The Financial Stability Board (FSB) released a report that offers insights into how financial institutions incorporate climate-related metrics into their compensation frameworks and identifies the related implementation challenges. FSB also issued a statement to encourage final preparations for the USD LIBOR transition and provided a summary of the meeting of the Regional Consultative Group for Europe. In July, FSB will finalize its recommendations for the regulation, supervision, and oversight of crypto-assets and markets and its revised recommendations specifically addressing global stablecoin arrangements.
The report on incorporation of climate risks into the compensation practices notes that the climate-related metrics incorporated in compensation frameworks include the reduction of carbon footprint, provision of sustainable finance and products, and accountability-type measures such as leadership in the climate-related area. Some financial institutions also use external-based metrics, such as ratings and indices, to benchmark themselves against their peers. The report identifies several common challenges, including gaps in data availability and reliability that make it difficult to apply consistent metrics, the development of objectively measurable metrics that align with financial institutions’ strategies, and the misalignment of timeframes between compensation assessment periods and the materialization of climate-related results. The report suggests that the incorporation of climate-related metrics into compensation frameworks will continue to evolve and that financial institutions need to continuously revise and adapt their metrics to respond to a rapidly changing environment to ensure the effective alignment of compensation with prudent risk-taking. Financial regulators can facilitate this process by sharing regulatory and industry practices with each other and with the industry.
With respect to the USD LIBOR transition, FSB urged market participants to act expeditiously to ensure that their legacy contracts are prepared to transition by end-June 2023. The following are the key highlights of the FSB statement:
- FSB encourages market participants to complete the transition of any remaining USD LIBOR-linked contracts now, in order to avoid a pile-up toward end-June 2023.
- The UK FCA has announced that it will require continued publication of the 1-, 3- and 6-month USD LIBOR settings following the end of the USD LIBOR panel, using a robust, unrepresentative synthetic methodology based on the CME Term SOFR Reference Rate and the ISDA fixed spread adjustment. FCA will permit the use of the synthetic settings in all legacy contracts except cleared derivatives. FCA intends that publication of these synthetic USD LIBOR settings will cease on September 30, 2024.
- FSB reminds market participants that they should not rely on the availability of synthetic LIBOR rates in place of active transition of legacy contracts. Any synthetic LIBOR provides only a short-term temporary bridge to alternative robust reference rates. Market participants need to continue to take active steps to address existing legacy contracts in preparation for the permanent cessation of USD LIBOR rates.
- For synthetic sterling LIBOR, FCA has announced its intention that the remaining 3-month setting will cease at end-March 2024. FSB reminds those market participants who still have remaining legacy contracts referencing 3-month sterling LIBOR to take necessary steps to ensure that they are prepared for its permanent cessation.
- Firms should continue to transition activity to robust reference rates, including the Secured Overnight Financing Rate (SOFR) for the USD, to support a sustainable transition and to promote financial stability. It is essential that the transition is anchored in risk-free reference rates that are robust and underpinned by deep, credible, and liquid markets to avoid the vulnerabilities experienced with LIBOR.
- International Organization of Securities Commissions (IOSCO) also launched a one-time review of credit sensitive rates and SOFR term rate alternatives to USD LIBOR that present themselves as compliant with the IOSCO Principles for Financial Benchmarks. The IOSCO review is expected to be finalized by June 2023.
Keywords: International, Banking, Climate Change Risk, ESG, Compensation Framework, LIBOR, Basel, Lending, Interest Rate Risk, Risk Free Rate, Systemic Risk, FSB
Hasan leads Moody’s Analytics ESG methodology development. He is expert on carbon transition, nature related risks and is a guest lecturer at ESSEC Business school on sustainable finance.
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