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IBOR transition
Opportunities and challenges for the
asset management industry
1 April 2020
Impact on asset managers and products4
Transition progress3
ECB EUR RFR working groups perspective5
How are firms migrating?6
Q&A7
Speaker introduction2
Webinar introduction1
Agenda
Joint EFAMA and EY IBOR transition webcast
To ask a question during the session,
please use the Q&A box to the left of
the slides.
Q&A
Page 1 April 2020
Speakers
Joint EFAMA and EY IBOR transition webcast
Agathi Pafili
Head of EU Government Relations at
Capital International Management
Company
Dr Anthony Kirby
EMEIA Wealth and Asset Management
Advisory Regulatory Intelligence and
IBOR Lead at EY
Silvia Devulder
Head Geneva Legal, Regulatory and
Compliance for Financial Services and
IBOR Legal Solution Lead, EY
Switzerland
Vincent Ingham
Director, Regulatory Policy at EFAMA,
the European Fund and Asset
Management Association
Page 2 April 2020
Speakers
April 2020 Joint EFAMA and EY IBOR transition webcastPage 3
Dr Anthony Kirby
Topic: IBOR transition progress
IBOR: historic background to changes foreseen in the markets
April 2020 Joint EFAMA and EY IBOR transition webcastPage 4
Drivers underpinning IBORs reform
Systemic risk due to the uncertainty
surrounding the durability of IBORs
Reluctance from LIBOR and EURIBOR
panel banks to submit quotes
Charges of attempted manipulation
and false reporting
Decline in the liquidity within the
interbank unsecured funding markets
Key reform initiatives by regulators globally and resulting outcomes
► Wheatley review of LIBOR >2012
► G20 asked the FSB to reform major interest rate benchmarks
► The official sector steering group (OSSG) established 2013
► IOSCO principles published 2013
► IBOR market participants group (MPG) established 2014
► Recommendation to enhance existing IBORs and promote alternative
nearly risk-free reference rates (RFRs).
► Working groups convened to propose alternative RFRs.
► Market participants have begun to assess the impacts
Interbank Offered Rates (IBORs) impact over $370tn notional value of financial instruments across the globe. Several cases of manipulation by banks of
major benchmarks and indices including IBORs have led to considerable censoring and initiation of reform by regulators globally to restore confidence in the
reliability and robustness of benchmark rates.
IBOR transition — situation in Europe
Joint EFAMA and EY IBOR transition webcast
Products affected by LIBOR transition (i.e.,
reference to floating interest rate benchmarks)
2018 2019 2021
High level timeline
Derivatives (ETD, OTC)
Loans (Consumer, Bilateral, Syndicated)
FRNs
Securitizations
Exotic derivatives,
e.g., CCY swaps, floors and caps
Indirectly — funds and mandates (e.g., benchmarks, etc.)
Key industry milestones in the UK: Reformed SONIA as alternative RFR for GBP LIBOR
IBORtransition
Validation of scope
High level impact
assessment
Deep dive gap analysis
Implementation program
setup and support
Embedding new processes LIBOR transitioned out by end 2021
01/04/20
Example timeline for IBOR transition at an asset manager
28 April 2017:
reformed
SONIA selected
23 April 2018:
reformed SONIA
benchmark effective
Dec 2017:
SONIA futures
published
1 January 2018: EU
benchmark regulation
(BMR) effective
End 2021: FCA announced
support to sustain LIBOR until
end of 2021
01 January 2020:
BMR transition
period ends
H2 2019: Term SONIA reference
rate available based on reformed
SONIA-derivatives market.
17 October 2020: LCH plans
Oct 2020 SOFR discounting
switch
2 March 2020: BoE/FCA call to
MMs to change market convention
for new swaps to SONIA
22 June 2020: eurex and
LCH plans Jun 2020 €STR
discounting switch
30 September 2020:
earliest date for withdrawing
LIBOR for loans in UK
2020
Page 5 April 2020
Summary of transition progress
Joint EFAMA and EY IBOR transition webcast
Working groups in each jurisdiction have recommended robust, alternative RFRs to transition away from existing IBORs. The RFR benchmarks are overnight whereas current use of IBORs is
largely in term rates.
Jurisdiction
IBORs GBP LIBOR USD LIBOR EURIBOR, Euro LIBOR CHF LIBOR JPY LIBOR, JPY TIBOR,
EUROYENTIBOR
Working Group Working group on sterling
risk-free reference rates
dear CEO letter
Alternative reference
rates committee
Working group on euro
risk-free rates
National working group on
Swiss franc reference Rate
dear CEO letter
Study group on risk-free
reference rates
Alternative RFR Reformed sterling overnight
index average (SONIA)
Secured overnight financing
rate (SOFR)
Euro short-term rate (ESTER) Swiss average rate overnight
(SARON)
Tokyo overnight average
rate (TONAR)
Description ► Unsecured
► Fully transaction-based
► Overnight, nearly risk-free
reference rate
► Includes a volume-weighted
trimmed mean
► Dear CEO letters issued to
banks/insurers in Sep 2018
and asset managers in Feb
2020
► Secured
► Fully transaction-based
► Overnight, nearly risk-free
reference rate that correlates
closely with other money
market rates
► Covers multiple repo market
segments, allowing for future
market evolution
► Unsecured
► In Sep 2018 ECB has
announced that ESTER is
chosen as ARR. Launched Oct
2019
► Reflects the wholesale
borrowing costs of euro area
banks
► Dear CEO letter issued by
ECB to banks in Jul 2019
► Secured
► Became the reference
interbank overnight repo
on 25 August 2009
► Secured rate that reflects
interest paid on interbank
overnight repo
► Unsecured, transaction-based
► Uncollateralized overnight call
rate market
► The Bank of Japan calculates and
publishes the rate daily using
information provided by money
market brokers, Tanshi
► As an average, weighted by the
volume of transactions
corresponding to the rate
Rate administrator Bank of England Fed. Res. Bank of New York ECB SIX Swiss Exchange Bank of Japan
Page 6 April 2020
April 2020 Joint EFAMA and EY IBOR transition webcastPage 7
“Failure to transition away from reliance on the London
Interbank Offered Rate (LIBOR) and other unsustainable
benchmarks may cause harm to market integrity and poor
outcomes for consumers. The FCA has made clear that firms
should plan on the basis that LIBOR will cease from the start of
2022. Your firm should recognise its responsibilities to facilitate
and contribute to an effective transition to new, more
appropriate rates, such as SONIA.”
– Marc Teasdale, Director of Wholesale Supervision
20 January 2020
Dear CEO letter on LIBOR from the FCA was addressed to dual-regulated firms and provided indication
of the FCA’s broad expectations.
“The continued reliance of global financial markets on Libor poses a risk to financial stability that
can only be reduced through a transition to alternative risk-free rates (RFRs) by end-2021’
– Financial Stability Report by The Financial Policy Committee
The FCA’s ‘Dear CEO’ letter issued (Feb 2020) stated: “LIBOR ending is a market event and the
transition to alternatives is market-led. We expect you to take proactive steps now where
appropriate and not to wait for instructions from clients…”
► The FCA expects firms to: “… take all reasonable steps to ensure the end of LIBOR does not lead to markets being disrupted or harm to consumers, and to support industry
initiatives to ensure a smooth transition” – this is pretty open-ended legally!
► The FCA recognises three key recommendations made by the Bank of England and Working Group on Sterling Risk-Free Reference Rates;
► Nick Miller’s letter features five focal points = 1) Products/Services; 2) Governance/Transition Planning; 3) Alternative Rates/Modelling; 4) 3rd Party Mandate Mgmt; 5)
Managing Conflicts;
► The letter draws attention to a particular Q&A focus on Conduct Risk – the hypertext link however links to a FCA page with examples drawn from the sell-side;
► Buy-side conduct risk areas, such as cited on link https://www.fca.org.uk/print/markets/libor/conduct-risk-during-libor-transition published 19th November 2019 are more
relevant;
► The new ‘transition for LIBOR’ FCA website hypertext link published - https://www.fca.org.uk/markets/libor.
Current Market Position — issue of ‘Dear CEO’ letters by the FCA
This follows the issue of ‘Dear CEO’ letters for dual-regulated firms in Sept. 2018
10 key client considerations
Joint EFAMA and EY IBOR transition webcast
It’s not just ‘new products’ IBOR has similar traits to previous mega programmes
Front to back nature The need for transition enablers
Number of external dependencies The challenge of appropriate testing
Conduct risk adds complexity Resource constraints
Dependency on key internal decisions Unforeseen downstream impact
Page 8 April 2020
Why act now?
Joint EFAMA and EY IBOR transition webcast
Late mobilization of execution could result in:
Increased costs in
2021 as
compressed
timelines and
scarcity of
talent/SMEs driving
project costs
higher
Increased delivery
risk due to reduced
ability to
proactively manage
dependencies and
less time
contingency
Increased
operational risk
due to reduced
time for testing,
with potential
implications for
downstream
consumers of data
Increased conduct
risk, as window to
approve new
products and
migrate clients
safely will be
compressed
Loss of market
share and
competitive
advantage as peers
are able to offer
alternative
products based on
RFRs
A worse client
experience with
greater potential
for confusion,
compounded by
their experience at
more advanced
peer firms
Page 9 April 2020
Current market position
EY Risk Management for Asset Management Survey — IBOR
April 2020 Joint EFAMA and EY IBOR transition webcastPage 10
Comparison of IBOR Risk Themes (NB: Early Stages only)
Established governance and organized cross-functional team 73%
Started firm-wide impact assessments to identify IBOR exposures 70%
54%
49%
51%
80%
Designed strategy to communicate implications/transition activities
Implemented 'no regret' actions to support trading of alternative RFRs
Firm started reviewed existing contractual fall-back provisions
Firm employing derivatives to hedge
Established GRC for IBOR migration in each country of scope
Managing Conflicts of Interest considered
Markets & strategic direction modelled
Enterprise Risk Management modelled
Valuation & Risk Mgmt. considered (e.g., Value Transfers/Collateral)
Capital Requirements and cross-impacts considered
Repapering of forward book modelled
Repapering of back book modelled (e.g., fall-backs/disclosures, etc.)
Cash flow hedges/hedge accounting/IAS39 & IFRS9 modelled
Transfer pricing/tax deductabilities, disclosures/returns evaluated
Operating models/operational changes to business delivery examined
Vendor applications examined and IT impact analysis
Communications with end investors started
56%
21%
37%
39%
60%
21%
28%
15%
1%
4%
11%
13%
32%
Current market position
WAM Client IBOR Timelines Reflect External Dependencies on Banks
April 2020 Joint EFAMA and EY IBOR transition webcastPage 11
More
Proactive?
More
Reactive?
ApproachtoIBOR
Starting Planning Early Analysis Gap Analysis
46%
22%
32%
KEY: Insurer-captive Bank-captive Independent
► Preparations are most advanced for Derivative/Swap-based products and
least for Loans. Retail firms are least prepared. The lack of historic data
for new RFRs hampered the calculation of stressed Expected Shortfall,
and will impact terms and contractual agreements such as fall-back
provisions;
► Firms who are captives of banking or insurance-HQd parents tended to
leverage their parent entities in order to drive specific
► Firms were relatively concerned at implementing consistent strengthened
fall-back language
► Consequences of lagging:
1. There could be extra capital add-ons
2. Extra delivery costs in a distressed environment under tight
timeframes leading to conduct/other risks
3. Risk of loss of market-share from more agile competitors
Sector Priorities
Program Mobilization and Technology Considerations
April 2020 Joint EFAMA and EY IBOR transition webcastPage 12
Federated
Centralised
6%
12%
30%
12%
6%
6%
24%
Program governance/design/
impact assessment
Modelling markets/
Valuations/ Risk Mgt.
Product governance and
design
Repapering fall-back &
disclosure legal services
Hedge accounting and IFRS
modelling
Tax deductabilities and tax
returns
Business/operating model
implementation
Vendor services and third
party coordination
4%
Expected areas of spend (Estimate at end 2019)Program Governance
Speakers
April 2020 Joint EFAMA and EY IBOR transition webcastPage 13
Silvia Devulder
Topic: Continuity of contracts
► With the UK regulatory announcements on 16 January 2020
re-iterating the need to substantially address the legacy
population for GBP trades by Q1 2021 firms must have
detailed and robust plans in place for updating legacy
documentation
► Most banks are looking to commence repapering of legacy
contracts in H2 of 2020 with most firms expecting the
process to last at least till the end
of 2021
► Most of the survey participants reported that their legal
teams do not have sufficient BAU capacity to cater for
reviewing all contracts required as part of the IBOR transition
► Over a third of survey participants stated that their outreach
efforts would involve more than 20,000 clients
Contract repapering
Joint EFAMA and EY IBOR transition webcast
Review and remediation of legacy contracts The majority of banks expect to leverage technology to
streamline efforts around contracts identification and
repapering
33%
33%
24%
19%
14%
We are currently analysing available
internal technology options and
potential external vendor solutions
Yes, for identification and scoping
Yes, for full end-to-end contract process
requirements
No
Other
Note: Percentages do not add up to 100% as some respondents selected more than one
answer option.
Page 14 April 2020
Specific areas of documentation impact for asset managers
April 2020 Joint EFAMA and EY IBOR transition webcastPage 15
Bilateral loan
documentation
ISDA/CSA
Local master
agreements
In-house
derivatives
agreements
LMA
syndicated loan
documentation
Non-standard
syndicated
loans
Other IBOR
impacted
agreements
GMRA
GMSLA
Other repo and
stocklending
agreements
Bonds, Floating
Rate Notes,
Certificates,
Commercial
paper, etc.
1 Illustrative
IBOR referred
as Benchmark
Investment
guidelines
IBOR Definition
(calculation
and purpose)
Management
objectives
Fund
prospectus
Performance
fees
Investment
strategy
Client transition
Joint EFAMA and EY IBOR transition webcast
► Perform contract review and due diligence exercise
to identify and remediate impacted contracts,
enabled by technology
► Determine client cohorts and set cohort treatment
strategy
► Consider conduct risk across the lifecycle of the
programme and embed into all workstreams
► Complete client outreach to proactively engage with
clients
Client cohort-led, Technology-enabled
Page 16 April 2020
Speakers
April 2020 Joint EFAMA and EY IBOR transition webcastPage 17
Agathi Pafili
Topic: ECB EUR RFR working group’s
perspective
EUR RFR WG — Key features
April 2020 Joint EFAMA and EY IBOR transition webcastPage 18
Mandate
► Strengthening existing interest rate benchmarks by underpinning them with transaction data as far as possible
► Developing alternative, nearly risk-free, reference rates (RFRs)
Composition /
Governance
► ECB, FSMA, ESMA and the EC initiated the launch of the EUR RFRF WG / first meeting in February 2018
► Private-led / Industry group chaired by a representative from the private sector / members from major banks
► Secretariat provided by the ECB
► ESMA, European Commission, FSMA and ECB participating as observers
► ISDA, EMMI, EFAMA and other industry representatives participate as non-voting members
Major EU
interest rates
► Euribor & Euro Overnight Index Average (EONIA) are based on the unsecured interbank market and designated as critical by the EC
► EURIBOR, a quote-based interest rate benchmark, available for several tenors
► EONIA, an overnight reference rate computed on the basis of real transactions in the interbank market, but has showed declining
geographic representation of the underlying market
Key deliverables
April 2020 Joint EFAMA and EY IBOR transition webcastPage 19
Recommend RFRs consistent with the
IOSCO principles & compliant with the
EU Regulation on Benchmarks
Recommend RFRs as best practice for
certain new derivatives and other
contracts, including mortgage
contracts
Alternative RFRs Contract Robustness Legacy contracts
Best practices for contract design
ensuring robustness and resilience to
the possible cessation or material
alteration of the underlying benchmark
Target: involving a broad group of
market participants via consultations
and dedicated hearings and outreach
ISDA’s role given the ongoing work in
the derivatives community
Creation of a plan and timeline for the
transition from current benchmarks
Sub-group for retail contracts in charge
of identifying appropriate alternatives
for term structured benchmarks
Milestones
April 2020 Joint EFAMA and EY IBOR transition webcastPage 20
September 2018:
Recommendation for the euro
short-term rate (€STER) to
become the new euro risk-free
rate and replace EONIA / €STER
will also provide a basis for
developing fallbacks for
contracts referencing the Euribor
March 2019: Modification of EONIA
methodology to become €STR plus a fixed
spread until end-2021 to facilitate
transition from EONIA to €STR &
recommendation for a methodology based
on OIS tradeable quotes for calculating a
€STR-based forward-looking term structure
as a fallback in EURIBOR-linked contracts
July 2019: Call for expressions
of interest — administrator for a
€STR-based forward-looking
term structure as a fallback in
EURIBOR-linked contracts
July 2019: Recommendations on
the legal action plan for new and
legacy contracts
August to November 2019:
Reports on the financial
accounting and risk management
implications of the transition and
its impact on cash and
derivatives products
November 2019:
Recommendations for fallback
arrangements for the €STR
Latest developments
April 2020 Joint EFAMA and EY IBOR transition webcastPage 21
WG’s actions Market & Regulatory developments
Euribor fallback
provisions
► High level
recommendations
(November 2019)
► Fallback provisions in
all new contracts
referencing EURIBOR
► Legacy contracts
referencing EURIBOR
should be covered by
robust written plans
► In legacy contracts
without appropriate
fallback provisions,
EURIBOR fallback
provisions should be
introduced
Seamless transition
from EONIA to €STR
► Recommendations to
support smooth
transfer of EONIA's
liquidity to the €STR
(February 2020)
► All stakeholders
should be made aware
that EONIA-linked
contracts with
maturities beyond 3
January 2022 entail
significant risks
Feedback on
Swaptions
► Public consultation
(deadline 30 April) on
Swaptions impacted
by the CCP discount
change from EONIA
to the €STR
► Feedback requested
as to whether the WG
should issue
recommendations
regarding the
voluntary exchange
(or lack thereof) of
cash compensation
between bilateral
counterparties to
swaption contracts
impacted by the CCP
discounting switch
from EONIA to the
€STR.
EUR discounting
► Eurex and LCH have
announced that EUR
discounting will switch
from EONIA to €STR
on 22 June 2020
ISDA statement
► Consultation on
Spread and Term
adjustments for
fallbacks in derivatives
referencing EUR
LIBOR and EURIBOR
► Majority of responses
ask for ‘compounded
setting in arrears rate
approach with a
backward-shift
adjustment’ and a
spread adjustment
based on a ‘historical
median over a five-
year lookback period’
EC endorsement of
IASB phase 1 on IBOR
► Commission’s
endorsement of the
IASB phase 1 IBOR
amendments in the
Official Journal.
► They provide
temporary and narrow
exemptions to the
hedge accounting
requirements of IAS
39, IFRS 9 and IFRS 7
Focus on investment funds
April 2020 Joint EFAMA and EY IBOR transition webcastPage 22
No official quantitative data on EONIA/Euribor usage as
an investment objective for funds across the asset
management sector. Nonetheless, the big majority of AMs
are in the process of conducting inventories of benchmark
usage in anticipation of implementing the transition and
assessing compliance with the BMR.
EFAMA surveyed its members on the EONIA usage in
November 2018 (see WG report as revised in March
2019) with the following results
► Money market and fixed income funds are the main
users of EONIA for benchmarking purposes
► No strategy change is expected as EONIA does not
have investible constituents, but this would need to be
assessed on a case-by-case basis
► The most commonly used instruments referencing
EONIA are floating rate notes, repurchase agreements,
interest rate derivatives and loan agreements
Respondents to EFAMA survey expected more than 12
months being necessary for the transition starting from
€STER’s publication
The transition includes among others modifications to
fund prospectuses, communication with clients and
adaptation of systems to cope with EONIA publication on a
T+1 basis
EFAMA also surveyed its members on the transition impact for cash
products and derivatives (see WG report, August 2019). In addition to
the previous findings, some funds, e.g., those pursuing liquid
strategies and total return/absolute strategies, may use EONIA as a
hurdle rate for performance fee calculations. The transition from
EONIA to the €STR will therefore also require amendments to the
calculation formulas and adjustments to the systems used by fund
administrators/ updates to prospectuses
The appropriate timing for a move to the €STR will depend on the
observed increase in liquidity
Risk management implications (see WG report, October 2019)
For NAV and risk calculations the new interest rates need to be
mapped to the respective instruments and a suitable way needs to be
found to move from the old regime to the new (e.g., IT applications)
without creating any disruptions or inconsistencies during the
transfer, for example regarding the effectiveness of hedges
Publication at T+1 could have a substantial impact on internal and
external reporting — especially where reports are produced over night
The transition could affect existing investment guidelines referring to
current IBORs (approval from both fund boards and clients)
Communication to clients: fair treatment and adequate disclosures —
where relevant renegotiate
BUT …
April 2020 Joint EFAMA and EY IBOR transition webcastPage 23
► There are important steps to take on an individual and bilateral basis — INERTIA NOT AN OPTION
► Following the WG’s recommendations doesn’t constitute a compliance safeguard
► Further engagement with national supervisors and market associations (such as ISDA) working on fallbacks and
contract continuity issues is highly recommended and in some cases necessary
► The working group’s recommendations are NOT legally binding on market participants.
► They provide orientation and represent the prevailing market consensus as regards the preferred euro risk-free rate
and the transition plan that market participants can put in place.
► Market participants still need to assess internally, negotiate and evaluate options with counterparties/ clients and
decide on the right transition plan on a bilateral basis.
Speakers
April 2020 Joint EFAMA and EY IBOR transition webcastPage 24
Dr Anthony Kirby
Topic: How are firms migrating?
Checklist of 10 things that asset managers are doing to prepare for transition?
Joint EFAMA and EY IBOR transition webcast
Program mobilization
Processes and systems
Accounting and Tax
Valuation and models
Agreements
Communication
Instruments and portfolios
Governance and controls
Impact assessment
Delegated funds
Project governance and PMO with clear roles and responsibilities to drive IBOR transition including high level solution design and
communication plan.
System capabilities with respect to backward fixing rates and products investigation; high level solution design; contract vendors
for system and valuation models to address external dependencies.
Inventory the impacted processes, policies and procedures, and update frameworks for fair value measurement and hedge
accounting.
Continuously analyze and quantify the financial impact of the valuation risk under different scenarios; strategic decisions
regarding model redevelopment and impact on the whole value chain of models for second order effects.
Inventory impacted customer contracts, and assess whether re-papering (and any updates to risk warnings and disclaimers) is
required. Impact assess client agreements, documentation and related processes, such as client consents.
Communication plan: clients, vendors, professional counterparties, externally managed funds and external funds, regulators and
internal employees.
Develop reinvestment strategy for IBOR related instruments; determine the indirect IBOR impact on funds and portfolios,
including on value, return or fees of a fund.
Review current governance models and existing controls, define a cross-functional governance model, and document and
implement changes to control frameworks.
Assess impacted products and functions, conduct gap assessment to identify Impacts to business and operating models,
particularly concerning data handling; develop a transition roadmap, and implement activities.
Start discussions re delegated funds to ensure alignment in transition approach and possible impact.
Page 25 April 2020
Why EY for IBOR?
Joint EFAMA and EY IBOR transition webcast
Strong connections with
global regulators, working
groups and trade bodies
Deep understanding of our
clients’ businesses, products
and infrastructure
Leading market position for IBOR,
underpinned by numerous client
engagements, accelerators,
methodologies and strategic third
party partnerships
Global integrated team with flexible
delivery models and skilled
resources across full E2E
proposition
WHY
EY?
Page 26 April 2020
Key takeaways
Joint EFAMA and EY IBOR transition webcast
IBOR transition will require substantial change for asset managers’ business critical functions and systems.
Country EY Contact Email Address
France Hermin Hologan hermin.hologan@fr.ey.com
Germany Patrick Stoess patrick.stoess@de.ey.com
Ireland Paul Traynor paul.traynor@ie.ey.com
Italy Giovanni Incarnato giovanni-andrea.incarnato@it.ey.com
Luxembourg Rafael Aguilera rafael.aguilera@lu.ey.com
Netherlands Wim Weijgertze wim.weijgertze@nl.ey.com
Nordics Fredrik Stigerud fredrik.stigerud@se.ey.com
Switzerland Christian Rothlin christian.roethlin@ch.ey.com
United Kingdom Simon Turner sturner@uk.ey.com
Page 27 April 2020
For more information, please contact your local EY member office:
EY | Assurance | Tax | Transactions | Advisory
About EY
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EY refers to the global organization, and may refer to one or more, of the
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Ernst & Young LLP, 1 More London Place, London, SE1 2AF.
© 2020 Ernst & Young LLP. Published in the UK.
All Rights Reserved.
EY-000118395-01 (UK) 03/20. CSG London.
EYG no. 001647-20Gbl
ED None
Information in this publication is intended to provide only a general outline of the subjects covered. It
should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be
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IBOR transition: Opportunities and challenges for the asset management industry

  • 1. IBOR transition Opportunities and challenges for the asset management industry 1 April 2020
  • 2. Impact on asset managers and products4 Transition progress3 ECB EUR RFR working groups perspective5 How are firms migrating?6 Q&A7 Speaker introduction2 Webinar introduction1 Agenda Joint EFAMA and EY IBOR transition webcast To ask a question during the session, please use the Q&A box to the left of the slides. Q&A Page 1 April 2020
  • 3. Speakers Joint EFAMA and EY IBOR transition webcast Agathi Pafili Head of EU Government Relations at Capital International Management Company Dr Anthony Kirby EMEIA Wealth and Asset Management Advisory Regulatory Intelligence and IBOR Lead at EY Silvia Devulder Head Geneva Legal, Regulatory and Compliance for Financial Services and IBOR Legal Solution Lead, EY Switzerland Vincent Ingham Director, Regulatory Policy at EFAMA, the European Fund and Asset Management Association Page 2 April 2020
  • 4. Speakers April 2020 Joint EFAMA and EY IBOR transition webcastPage 3 Dr Anthony Kirby Topic: IBOR transition progress
  • 5. IBOR: historic background to changes foreseen in the markets April 2020 Joint EFAMA and EY IBOR transition webcastPage 4 Drivers underpinning IBORs reform Systemic risk due to the uncertainty surrounding the durability of IBORs Reluctance from LIBOR and EURIBOR panel banks to submit quotes Charges of attempted manipulation and false reporting Decline in the liquidity within the interbank unsecured funding markets Key reform initiatives by regulators globally and resulting outcomes ► Wheatley review of LIBOR >2012 ► G20 asked the FSB to reform major interest rate benchmarks ► The official sector steering group (OSSG) established 2013 ► IOSCO principles published 2013 ► IBOR market participants group (MPG) established 2014 ► Recommendation to enhance existing IBORs and promote alternative nearly risk-free reference rates (RFRs). ► Working groups convened to propose alternative RFRs. ► Market participants have begun to assess the impacts Interbank Offered Rates (IBORs) impact over $370tn notional value of financial instruments across the globe. Several cases of manipulation by banks of major benchmarks and indices including IBORs have led to considerable censoring and initiation of reform by regulators globally to restore confidence in the reliability and robustness of benchmark rates.
  • 6. IBOR transition — situation in Europe Joint EFAMA and EY IBOR transition webcast Products affected by LIBOR transition (i.e., reference to floating interest rate benchmarks) 2018 2019 2021 High level timeline Derivatives (ETD, OTC) Loans (Consumer, Bilateral, Syndicated) FRNs Securitizations Exotic derivatives, e.g., CCY swaps, floors and caps Indirectly — funds and mandates (e.g., benchmarks, etc.) Key industry milestones in the UK: Reformed SONIA as alternative RFR for GBP LIBOR IBORtransition Validation of scope High level impact assessment Deep dive gap analysis Implementation program setup and support Embedding new processes LIBOR transitioned out by end 2021 01/04/20 Example timeline for IBOR transition at an asset manager 28 April 2017: reformed SONIA selected 23 April 2018: reformed SONIA benchmark effective Dec 2017: SONIA futures published 1 January 2018: EU benchmark regulation (BMR) effective End 2021: FCA announced support to sustain LIBOR until end of 2021 01 January 2020: BMR transition period ends H2 2019: Term SONIA reference rate available based on reformed SONIA-derivatives market. 17 October 2020: LCH plans Oct 2020 SOFR discounting switch 2 March 2020: BoE/FCA call to MMs to change market convention for new swaps to SONIA 22 June 2020: eurex and LCH plans Jun 2020 €STR discounting switch 30 September 2020: earliest date for withdrawing LIBOR for loans in UK 2020 Page 5 April 2020
  • 7. Summary of transition progress Joint EFAMA and EY IBOR transition webcast Working groups in each jurisdiction have recommended robust, alternative RFRs to transition away from existing IBORs. The RFR benchmarks are overnight whereas current use of IBORs is largely in term rates. Jurisdiction IBORs GBP LIBOR USD LIBOR EURIBOR, Euro LIBOR CHF LIBOR JPY LIBOR, JPY TIBOR, EUROYENTIBOR Working Group Working group on sterling risk-free reference rates dear CEO letter Alternative reference rates committee Working group on euro risk-free rates National working group on Swiss franc reference Rate dear CEO letter Study group on risk-free reference rates Alternative RFR Reformed sterling overnight index average (SONIA) Secured overnight financing rate (SOFR) Euro short-term rate (ESTER) Swiss average rate overnight (SARON) Tokyo overnight average rate (TONAR) Description ► Unsecured ► Fully transaction-based ► Overnight, nearly risk-free reference rate ► Includes a volume-weighted trimmed mean ► Dear CEO letters issued to banks/insurers in Sep 2018 and asset managers in Feb 2020 ► Secured ► Fully transaction-based ► Overnight, nearly risk-free reference rate that correlates closely with other money market rates ► Covers multiple repo market segments, allowing for future market evolution ► Unsecured ► In Sep 2018 ECB has announced that ESTER is chosen as ARR. Launched Oct 2019 ► Reflects the wholesale borrowing costs of euro area banks ► Dear CEO letter issued by ECB to banks in Jul 2019 ► Secured ► Became the reference interbank overnight repo on 25 August 2009 ► Secured rate that reflects interest paid on interbank overnight repo ► Unsecured, transaction-based ► Uncollateralized overnight call rate market ► The Bank of Japan calculates and publishes the rate daily using information provided by money market brokers, Tanshi ► As an average, weighted by the volume of transactions corresponding to the rate Rate administrator Bank of England Fed. Res. Bank of New York ECB SIX Swiss Exchange Bank of Japan Page 6 April 2020
  • 8. April 2020 Joint EFAMA and EY IBOR transition webcastPage 7 “Failure to transition away from reliance on the London Interbank Offered Rate (LIBOR) and other unsustainable benchmarks may cause harm to market integrity and poor outcomes for consumers. The FCA has made clear that firms should plan on the basis that LIBOR will cease from the start of 2022. Your firm should recognise its responsibilities to facilitate and contribute to an effective transition to new, more appropriate rates, such as SONIA.” – Marc Teasdale, Director of Wholesale Supervision 20 January 2020 Dear CEO letter on LIBOR from the FCA was addressed to dual-regulated firms and provided indication of the FCA’s broad expectations. “The continued reliance of global financial markets on Libor poses a risk to financial stability that can only be reduced through a transition to alternative risk-free rates (RFRs) by end-2021’ – Financial Stability Report by The Financial Policy Committee The FCA’s ‘Dear CEO’ letter issued (Feb 2020) stated: “LIBOR ending is a market event and the transition to alternatives is market-led. We expect you to take proactive steps now where appropriate and not to wait for instructions from clients…” ► The FCA expects firms to: “… take all reasonable steps to ensure the end of LIBOR does not lead to markets being disrupted or harm to consumers, and to support industry initiatives to ensure a smooth transition” – this is pretty open-ended legally! ► The FCA recognises three key recommendations made by the Bank of England and Working Group on Sterling Risk-Free Reference Rates; ► Nick Miller’s letter features five focal points = 1) Products/Services; 2) Governance/Transition Planning; 3) Alternative Rates/Modelling; 4) 3rd Party Mandate Mgmt; 5) Managing Conflicts; ► The letter draws attention to a particular Q&A focus on Conduct Risk – the hypertext link however links to a FCA page with examples drawn from the sell-side; ► Buy-side conduct risk areas, such as cited on link https://www.fca.org.uk/print/markets/libor/conduct-risk-during-libor-transition published 19th November 2019 are more relevant; ► The new ‘transition for LIBOR’ FCA website hypertext link published - https://www.fca.org.uk/markets/libor. Current Market Position — issue of ‘Dear CEO’ letters by the FCA This follows the issue of ‘Dear CEO’ letters for dual-regulated firms in Sept. 2018
  • 9. 10 key client considerations Joint EFAMA and EY IBOR transition webcast It’s not just ‘new products’ IBOR has similar traits to previous mega programmes Front to back nature The need for transition enablers Number of external dependencies The challenge of appropriate testing Conduct risk adds complexity Resource constraints Dependency on key internal decisions Unforeseen downstream impact Page 8 April 2020
  • 10. Why act now? Joint EFAMA and EY IBOR transition webcast Late mobilization of execution could result in: Increased costs in 2021 as compressed timelines and scarcity of talent/SMEs driving project costs higher Increased delivery risk due to reduced ability to proactively manage dependencies and less time contingency Increased operational risk due to reduced time for testing, with potential implications for downstream consumers of data Increased conduct risk, as window to approve new products and migrate clients safely will be compressed Loss of market share and competitive advantage as peers are able to offer alternative products based on RFRs A worse client experience with greater potential for confusion, compounded by their experience at more advanced peer firms Page 9 April 2020
  • 11. Current market position EY Risk Management for Asset Management Survey — IBOR April 2020 Joint EFAMA and EY IBOR transition webcastPage 10 Comparison of IBOR Risk Themes (NB: Early Stages only) Established governance and organized cross-functional team 73% Started firm-wide impact assessments to identify IBOR exposures 70% 54% 49% 51% 80% Designed strategy to communicate implications/transition activities Implemented 'no regret' actions to support trading of alternative RFRs Firm started reviewed existing contractual fall-back provisions Firm employing derivatives to hedge Established GRC for IBOR migration in each country of scope Managing Conflicts of Interest considered Markets & strategic direction modelled Enterprise Risk Management modelled Valuation & Risk Mgmt. considered (e.g., Value Transfers/Collateral) Capital Requirements and cross-impacts considered Repapering of forward book modelled Repapering of back book modelled (e.g., fall-backs/disclosures, etc.) Cash flow hedges/hedge accounting/IAS39 & IFRS9 modelled Transfer pricing/tax deductabilities, disclosures/returns evaluated Operating models/operational changes to business delivery examined Vendor applications examined and IT impact analysis Communications with end investors started 56% 21% 37% 39% 60% 21% 28% 15% 1% 4% 11% 13% 32%
  • 12. Current market position WAM Client IBOR Timelines Reflect External Dependencies on Banks April 2020 Joint EFAMA and EY IBOR transition webcastPage 11 More Proactive? More Reactive? ApproachtoIBOR Starting Planning Early Analysis Gap Analysis 46% 22% 32% KEY: Insurer-captive Bank-captive Independent ► Preparations are most advanced for Derivative/Swap-based products and least for Loans. Retail firms are least prepared. The lack of historic data for new RFRs hampered the calculation of stressed Expected Shortfall, and will impact terms and contractual agreements such as fall-back provisions; ► Firms who are captives of banking or insurance-HQd parents tended to leverage their parent entities in order to drive specific ► Firms were relatively concerned at implementing consistent strengthened fall-back language ► Consequences of lagging: 1. There could be extra capital add-ons 2. Extra delivery costs in a distressed environment under tight timeframes leading to conduct/other risks 3. Risk of loss of market-share from more agile competitors
  • 13. Sector Priorities Program Mobilization and Technology Considerations April 2020 Joint EFAMA and EY IBOR transition webcastPage 12 Federated Centralised 6% 12% 30% 12% 6% 6% 24% Program governance/design/ impact assessment Modelling markets/ Valuations/ Risk Mgt. Product governance and design Repapering fall-back & disclosure legal services Hedge accounting and IFRS modelling Tax deductabilities and tax returns Business/operating model implementation Vendor services and third party coordination 4% Expected areas of spend (Estimate at end 2019)Program Governance
  • 14. Speakers April 2020 Joint EFAMA and EY IBOR transition webcastPage 13 Silvia Devulder Topic: Continuity of contracts
  • 15. ► With the UK regulatory announcements on 16 January 2020 re-iterating the need to substantially address the legacy population for GBP trades by Q1 2021 firms must have detailed and robust plans in place for updating legacy documentation ► Most banks are looking to commence repapering of legacy contracts in H2 of 2020 with most firms expecting the process to last at least till the end of 2021 ► Most of the survey participants reported that their legal teams do not have sufficient BAU capacity to cater for reviewing all contracts required as part of the IBOR transition ► Over a third of survey participants stated that their outreach efforts would involve more than 20,000 clients Contract repapering Joint EFAMA and EY IBOR transition webcast Review and remediation of legacy contracts The majority of banks expect to leverage technology to streamline efforts around contracts identification and repapering 33% 33% 24% 19% 14% We are currently analysing available internal technology options and potential external vendor solutions Yes, for identification and scoping Yes, for full end-to-end contract process requirements No Other Note: Percentages do not add up to 100% as some respondents selected more than one answer option. Page 14 April 2020
  • 16. Specific areas of documentation impact for asset managers April 2020 Joint EFAMA and EY IBOR transition webcastPage 15 Bilateral loan documentation ISDA/CSA Local master agreements In-house derivatives agreements LMA syndicated loan documentation Non-standard syndicated loans Other IBOR impacted agreements GMRA GMSLA Other repo and stocklending agreements Bonds, Floating Rate Notes, Certificates, Commercial paper, etc. 1 Illustrative IBOR referred as Benchmark Investment guidelines IBOR Definition (calculation and purpose) Management objectives Fund prospectus Performance fees Investment strategy
  • 17. Client transition Joint EFAMA and EY IBOR transition webcast ► Perform contract review and due diligence exercise to identify and remediate impacted contracts, enabled by technology ► Determine client cohorts and set cohort treatment strategy ► Consider conduct risk across the lifecycle of the programme and embed into all workstreams ► Complete client outreach to proactively engage with clients Client cohort-led, Technology-enabled Page 16 April 2020
  • 18. Speakers April 2020 Joint EFAMA and EY IBOR transition webcastPage 17 Agathi Pafili Topic: ECB EUR RFR working group’s perspective
  • 19. EUR RFR WG — Key features April 2020 Joint EFAMA and EY IBOR transition webcastPage 18 Mandate ► Strengthening existing interest rate benchmarks by underpinning them with transaction data as far as possible ► Developing alternative, nearly risk-free, reference rates (RFRs) Composition / Governance ► ECB, FSMA, ESMA and the EC initiated the launch of the EUR RFRF WG / first meeting in February 2018 ► Private-led / Industry group chaired by a representative from the private sector / members from major banks ► Secretariat provided by the ECB ► ESMA, European Commission, FSMA and ECB participating as observers ► ISDA, EMMI, EFAMA and other industry representatives participate as non-voting members Major EU interest rates ► Euribor & Euro Overnight Index Average (EONIA) are based on the unsecured interbank market and designated as critical by the EC ► EURIBOR, a quote-based interest rate benchmark, available for several tenors ► EONIA, an overnight reference rate computed on the basis of real transactions in the interbank market, but has showed declining geographic representation of the underlying market
  • 20. Key deliverables April 2020 Joint EFAMA and EY IBOR transition webcastPage 19 Recommend RFRs consistent with the IOSCO principles & compliant with the EU Regulation on Benchmarks Recommend RFRs as best practice for certain new derivatives and other contracts, including mortgage contracts Alternative RFRs Contract Robustness Legacy contracts Best practices for contract design ensuring robustness and resilience to the possible cessation or material alteration of the underlying benchmark Target: involving a broad group of market participants via consultations and dedicated hearings and outreach ISDA’s role given the ongoing work in the derivatives community Creation of a plan and timeline for the transition from current benchmarks Sub-group for retail contracts in charge of identifying appropriate alternatives for term structured benchmarks
  • 21. Milestones April 2020 Joint EFAMA and EY IBOR transition webcastPage 20 September 2018: Recommendation for the euro short-term rate (€STER) to become the new euro risk-free rate and replace EONIA / €STER will also provide a basis for developing fallbacks for contracts referencing the Euribor March 2019: Modification of EONIA methodology to become €STR plus a fixed spread until end-2021 to facilitate transition from EONIA to €STR & recommendation for a methodology based on OIS tradeable quotes for calculating a €STR-based forward-looking term structure as a fallback in EURIBOR-linked contracts July 2019: Call for expressions of interest — administrator for a €STR-based forward-looking term structure as a fallback in EURIBOR-linked contracts July 2019: Recommendations on the legal action plan for new and legacy contracts August to November 2019: Reports on the financial accounting and risk management implications of the transition and its impact on cash and derivatives products November 2019: Recommendations for fallback arrangements for the €STR
  • 22. Latest developments April 2020 Joint EFAMA and EY IBOR transition webcastPage 21 WG’s actions Market & Regulatory developments Euribor fallback provisions ► High level recommendations (November 2019) ► Fallback provisions in all new contracts referencing EURIBOR ► Legacy contracts referencing EURIBOR should be covered by robust written plans ► In legacy contracts without appropriate fallback provisions, EURIBOR fallback provisions should be introduced Seamless transition from EONIA to €STR ► Recommendations to support smooth transfer of EONIA's liquidity to the €STR (February 2020) ► All stakeholders should be made aware that EONIA-linked contracts with maturities beyond 3 January 2022 entail significant risks Feedback on Swaptions ► Public consultation (deadline 30 April) on Swaptions impacted by the CCP discount change from EONIA to the €STR ► Feedback requested as to whether the WG should issue recommendations regarding the voluntary exchange (or lack thereof) of cash compensation between bilateral counterparties to swaption contracts impacted by the CCP discounting switch from EONIA to the €STR. EUR discounting ► Eurex and LCH have announced that EUR discounting will switch from EONIA to €STR on 22 June 2020 ISDA statement ► Consultation on Spread and Term adjustments for fallbacks in derivatives referencing EUR LIBOR and EURIBOR ► Majority of responses ask for ‘compounded setting in arrears rate approach with a backward-shift adjustment’ and a spread adjustment based on a ‘historical median over a five- year lookback period’ EC endorsement of IASB phase 1 on IBOR ► Commission’s endorsement of the IASB phase 1 IBOR amendments in the Official Journal. ► They provide temporary and narrow exemptions to the hedge accounting requirements of IAS 39, IFRS 9 and IFRS 7
  • 23. Focus on investment funds April 2020 Joint EFAMA and EY IBOR transition webcastPage 22 No official quantitative data on EONIA/Euribor usage as an investment objective for funds across the asset management sector. Nonetheless, the big majority of AMs are in the process of conducting inventories of benchmark usage in anticipation of implementing the transition and assessing compliance with the BMR. EFAMA surveyed its members on the EONIA usage in November 2018 (see WG report as revised in March 2019) with the following results ► Money market and fixed income funds are the main users of EONIA for benchmarking purposes ► No strategy change is expected as EONIA does not have investible constituents, but this would need to be assessed on a case-by-case basis ► The most commonly used instruments referencing EONIA are floating rate notes, repurchase agreements, interest rate derivatives and loan agreements Respondents to EFAMA survey expected more than 12 months being necessary for the transition starting from €STER’s publication The transition includes among others modifications to fund prospectuses, communication with clients and adaptation of systems to cope with EONIA publication on a T+1 basis EFAMA also surveyed its members on the transition impact for cash products and derivatives (see WG report, August 2019). In addition to the previous findings, some funds, e.g., those pursuing liquid strategies and total return/absolute strategies, may use EONIA as a hurdle rate for performance fee calculations. The transition from EONIA to the €STR will therefore also require amendments to the calculation formulas and adjustments to the systems used by fund administrators/ updates to prospectuses The appropriate timing for a move to the €STR will depend on the observed increase in liquidity Risk management implications (see WG report, October 2019) For NAV and risk calculations the new interest rates need to be mapped to the respective instruments and a suitable way needs to be found to move from the old regime to the new (e.g., IT applications) without creating any disruptions or inconsistencies during the transfer, for example regarding the effectiveness of hedges Publication at T+1 could have a substantial impact on internal and external reporting — especially where reports are produced over night The transition could affect existing investment guidelines referring to current IBORs (approval from both fund boards and clients) Communication to clients: fair treatment and adequate disclosures — where relevant renegotiate
  • 24. BUT … April 2020 Joint EFAMA and EY IBOR transition webcastPage 23 ► There are important steps to take on an individual and bilateral basis — INERTIA NOT AN OPTION ► Following the WG’s recommendations doesn’t constitute a compliance safeguard ► Further engagement with national supervisors and market associations (such as ISDA) working on fallbacks and contract continuity issues is highly recommended and in some cases necessary ► The working group’s recommendations are NOT legally binding on market participants. ► They provide orientation and represent the prevailing market consensus as regards the preferred euro risk-free rate and the transition plan that market participants can put in place. ► Market participants still need to assess internally, negotiate and evaluate options with counterparties/ clients and decide on the right transition plan on a bilateral basis.
  • 25. Speakers April 2020 Joint EFAMA and EY IBOR transition webcastPage 24 Dr Anthony Kirby Topic: How are firms migrating?
  • 26. Checklist of 10 things that asset managers are doing to prepare for transition? Joint EFAMA and EY IBOR transition webcast Program mobilization Processes and systems Accounting and Tax Valuation and models Agreements Communication Instruments and portfolios Governance and controls Impact assessment Delegated funds Project governance and PMO with clear roles and responsibilities to drive IBOR transition including high level solution design and communication plan. System capabilities with respect to backward fixing rates and products investigation; high level solution design; contract vendors for system and valuation models to address external dependencies. Inventory the impacted processes, policies and procedures, and update frameworks for fair value measurement and hedge accounting. Continuously analyze and quantify the financial impact of the valuation risk under different scenarios; strategic decisions regarding model redevelopment and impact on the whole value chain of models for second order effects. Inventory impacted customer contracts, and assess whether re-papering (and any updates to risk warnings and disclaimers) is required. Impact assess client agreements, documentation and related processes, such as client consents. Communication plan: clients, vendors, professional counterparties, externally managed funds and external funds, regulators and internal employees. Develop reinvestment strategy for IBOR related instruments; determine the indirect IBOR impact on funds and portfolios, including on value, return or fees of a fund. Review current governance models and existing controls, define a cross-functional governance model, and document and implement changes to control frameworks. Assess impacted products and functions, conduct gap assessment to identify Impacts to business and operating models, particularly concerning data handling; develop a transition roadmap, and implement activities. Start discussions re delegated funds to ensure alignment in transition approach and possible impact. Page 25 April 2020
  • 27. Why EY for IBOR? Joint EFAMA and EY IBOR transition webcast Strong connections with global regulators, working groups and trade bodies Deep understanding of our clients’ businesses, products and infrastructure Leading market position for IBOR, underpinned by numerous client engagements, accelerators, methodologies and strategic third party partnerships Global integrated team with flexible delivery models and skilled resources across full E2E proposition WHY EY? Page 26 April 2020
  • 28. Key takeaways Joint EFAMA and EY IBOR transition webcast IBOR transition will require substantial change for asset managers’ business critical functions and systems. Country EY Contact Email Address France Hermin Hologan hermin.hologan@fr.ey.com Germany Patrick Stoess patrick.stoess@de.ey.com Ireland Paul Traynor paul.traynor@ie.ey.com Italy Giovanni Incarnato giovanni-andrea.incarnato@it.ey.com Luxembourg Rafael Aguilera rafael.aguilera@lu.ey.com Netherlands Wim Weijgertze wim.weijgertze@nl.ey.com Nordics Fredrik Stigerud fredrik.stigerud@se.ey.com Switzerland Christian Rothlin christian.roethlin@ch.ey.com United Kingdom Simon Turner sturner@uk.ey.com Page 27 April 2020 For more information, please contact your local EY member office:
  • 29. EY | Assurance | Tax | Transactions | Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. Information about how EY collects and uses personal data and a description of the rights individuals have under data protection legislation are available via ey.com/privacy. For more information about our organization, please visit ey.com. Ernst & Young LLP The UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC300001 and is a member firm of Ernst & Young Global Limited. Ernst & Young LLP, 1 More London Place, London, SE1 2AF. © 2020 Ernst & Young LLP. Published in the UK. All Rights Reserved. EY-000118395-01 (UK) 03/20. CSG London. EYG no. 001647-20Gbl ED None Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Ernst & Young LLP accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material. ey.com/uk