ECB Outlines Good Practices for Banks to Prepare for Benchmark Reforms
ECB published a report that outlines good practices for banks to prepare for benchmark rate reforms. The good practices address how banks can best structure their benchmark-rate-related governance, identify benchmark-rate-related risks, and create action plans and documentation in relation to the reforms. Also published were the results of an industry-wide assessment of the banks' preparedness for the benchmark interest rate reforms. One of the key findings of the assessment is that, while banks are generally well aware of the potential risks entailed in the benchmark rate reforms, they are behind schedule in developing and implementing the risk mitigation measures with respect to the benchmark reforms.
In July 2019, ECB had surveyed certain supervised banks to assess their preparedness for the interest rate reforms under the EU Benchmarks Regulation. The assessment found that banks have focused more on the transition phase from the euro overnight index average (EONIA) to the euro short-term rate (€STR) than on the reform of the euro interbank offered rate (EURIBOR) and its associated risks. EURIBOR is the main benchmark rate in the euro area in terms of the number of contracts that reference it and is widely used in retail loans and hedging products. In light of the results of this assessment, ECB has now published the report on preparations for benchmark rate reforms, which sets out the good practices that were identified in the documentation that banks submitted to ECB in 2019.. The key areas in which the report provides examples of good practices include the following:
- Governance. To mitigate impact of the benchmark rate reforms in a proactive and sustainable manner, banks should have a suitable organizational and operational structure in place, including an adequate segregation of duties and clear reporting lines, as set out in paragraph 67 of the EBA guidelines on internal governance.
- Risk Identification. Internal risk assessment is a critical step, as it is the starting point for devising the action plan. It is, therefore, important to allocate the necessary resources and time to this step.
- Action Plan. Including action plans in a dedicated risk assessment means that they can prioritize and hone risk mitigation activities in a targeted manner and thereby ensure granular coverage of all the relevant aspects identified.
- Timeline. Setting a clear timeline can help in finding comprehensive solutions that will provide the Single Supervisory Mechanism banks with the time they need to develop, test, and implement robust mitigation measures.
- Awareness of External Development. ECB expects banks to fully comply with the legal requirements. Given the work underway in a number of fora, banks face the challenge of ensuring that they are up-to-date with the most recent developments (for example, actions by central counterparties).
The report highlights that, as a general principle, the assessment of legal and operational challenges is best performed holistically, taking into consideration both internal systems and external factors such as risks relating to conduct, reputation, and litigation. The report also discusses exposure-related risks with regard to valuation and regulatory treatment. While this report does not cover good practices in relation to the application of accounting standards, it is important from a prudential perspective that banks are aware of potential accounting implications stemming from the benchmark rate reforms and their potential significance.
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Keywords: Europe, EU, Banking, Securities, EONIA, €STR, Risk-Free Rates, Interest Rate Benchmarks, EURIOR, Benchmarks Regulation, IBOR Reform, ECB
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