There is no peace for the wicked! Much as big UK banks would like to focus on digital transformation and customers, products and services, the icy hand of past failings will continue to use a large proportion of the IT, Operations and change resources for the next few years. This article forecasts the main areas of work.
The big 5 UK banks (Barclays, HSBC, Lloyds, RBS and Santander) are just coming through their monster Ring Fencing projects which have consumed so much IT and change capability for the last two years. They “talk the talk” about putting the past behind them, but the regulators are not so convinced they have got there. The era of fines and customer compensation may be coming to an end, but the systemic changes keep on coming. Here is HBW’s forecast on the big multiyear programmes for 2019 to 2021.
LIBOR rigging generated a lot of very bad publicity and fines for banks and their employees for several years, however the project to implement the replacement for LIBOR is only just starting and it will be very substantial. Key features of this will be;
* Corporate and commercial lending – most big loans in the UK are sold as variable rate loans with LIBOR as the reference rate (actually reference rates plural as there are different rates for different currencies and different tenors such as overnight 1 month, 3 month etc). These rates are often referenced in the loan contracts in multiple ways; the main rate but also for various error conditions in breach clauses, fallback clauses etc. These contracts are generally bespoke to each deal. This means that these will be major programmes to re-negotiate the contracts with corporate and commercial customers, lots of work for lawyers! Additionally, because there is unlikely to be a like for like replacement of LIBOR rates, there will probably be complicated changes in the loan operations areas (syndicated lending, rate rollovers, product types) to manage.
* Quite how LIBOR will stop is unclear (hard stop, tail etc) but the FCA has made it clear that Banks will have to stop using LIBOR by end 2021. Dealing with this “end of LIBOR” is both a “front book” problem for contracts written now forwards in time and a “back book” problem for contracts already written with a maturity post 2021.
* Derivatives; there is a huge number of contracts based on LIBOR in the Interest Rate Derivatives markets. These will need to work legally with the new reference rates. Whilst ISDA contracts standards mean there is some industry level ability to manage the changes, the lack of a one for one replacement of the reference rates means that there will be systems and operations charges to manage in each and every trading room.
* Treasury and Funding; big UK banks use central funding rates (i.e. the internal cost of funds for loan products or the price to pay for funds from deposit products) to manage products and product pricing. These are usually based on LIBOR and these funding rates flow, like blood through the arteries of many, many systems across the bank. To replace LIBOR will require a very well architected set of IT charges in all these systems, especially as the nature of the replacement rates will differ in some important respects to LIBOR (e.g. the lack of a credit risk element).
Andrew Bailey (the chair of the FCA) gave a speech in July 2018 emphasising the need for increased pace in the LIBOR replacement projects of banks which can be read here.
Resolution Planning – Valuations
Resolution Planning (or living Wills as it has been called) is not a new thing at all, but it has a long way to go before the regulators feel the big banks are capable of being managed safely in a financial crisis. In 2017/18, the focus was on an aspect called Operational Continuity. In 2019 and 2020, the focus will be much more on developing capabilities to be able to value a bank’s balance sheet speedily. Currently, banks can only do a thorough valuation once a year as part of the painful, month long, end of financial year financial statements process. This is of no use if a bank fails mid way through a year in a hurry. The Bank of England has set out a policy for compliance by 1/1/2021 for what it expects banks to be able to do (available here).
The essence of the task is a major upgrade to the whole Finance General Ledger and reporting system, both IT and human. The aim is to move a process that can only run once a year to be able to be run at least once a month and preferably daily. Furthermore, the elapsed time for the process has to come down from 30 plus working days to an elapsed period measured in single figures of working days. Financially, alternative valuation methodologies (such as mark to market, fire sale valuation) have to be added to the standard accounting rules. This represents a lot of skill intensive charge resource in Finance Change Departments in Big Banks.
People may be forgiven for thinking that with the legal deadline of May 2018 having passed GDPR has finished as a change activity for the big banks. Not a bit of it. They have got such a long way to go with (particularly IT) GDPR changes that there will be big programmes of work going out well into 2020. Areas of charge involve:
* Making the whole retention/ detention process for personal data compliant in computer systems.
* Making efficient the Data Access request process given they are largely very manual today.
* Providing individuals better tools for managing their own data permissions.
This is not strictly a regulatory driven thing but Banks would say Brexit is very much a regulatory distraction from their aim of supporting customers. Although the politicians
have not made clear what is going to happen, nor will it realistically be clear until very late 2018 (at best) there will be a number of projects in 2019 and beyond.
* The time for making decisions about March 2019 structural reform for banks in the UK has passed the point of no return. They have had to assume a hard Brexit and start creating the relevant legal entities and obtaining banking licences/ permssions in both the UK and the EEEA to allow them to sell products and services in both the UK and the EEA. The assumption is that there is no passporting or regulatory equivalence regime. The work required involves setting up these structures in the banks systems and putting in processes for booking contracts, reporting on and managing the new legal entities.
* Despite the Hard Brexit assumption, there are a wide variety of open issues, particularly related to past contracts with maturity beyond March 2019 which will need some form of remediation approach and will likely form a transition period (i.e. to December 2020) project.
* Finally, given the lack of certainty, most big banks are currently planning on just trying to keep services going for their existing customers and markets. Depending on how the regulatory landscape settles post Brexit, the banks will then take a hard look at how economically viable some of their cross border activities are. Possible issues could be trapped capital and liquidity, cross border tax issues, staff mobility and permissions. As a result, it is very likely that a third wave of Brexit project will be necessary to address these economic constraints, including business divestments and wind downs.
Open Banking and PSDII limped into life in Feb 2018 but this was only the start. First of all, the Secure Customer Authentication requirements have to be implemented into the Banks’ own electronic channels. These are significant changes which could impact the usability of these channels.
In the UK, the competitions and Markets Authority (CMA) require a lot more opening up of the big banks systems capabilities. (See the latest roadmap here). This will drive a lot of IT change in the Core Banking and payments systems parts of the big UK banks. Examples of changes are:
* International payment instructions from third party providers.
* Standing orders and direct debit set up and maintenance from third party apps.
* New generations of security including multiparty authorisation.
Although we are a decade on from the financial crisis of 2007/8, the change agenda in big UK banks in large part continues to be driven by the regulators. Not all of it relates to the problems of those times but the “light touch” regulatory environment that in large measure contributed to the banking crisis is absolutely not in plan for the next few years. Banks, in particular the operations, change and IT functions need to be staffed and skilled to cope with the considerable demand for regulatory change coming between 2018 and 2021; many hundreds of millions of pounds per annum over this period. All this while the banks are seeking to reduce costs in a low growth, low-interest rate environment.