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Legal Data Management in Financial Institutions – a new approach

The need to transition away from LIBOR to alternative reference rates today presents a substantial challenge for financial institutions. With the end of 2021 deadline looming, firms need to find and update all references to IBORs embedded in all the contracts they hold; accurately reflecting the fallback provisions / terms of the alternative reference rate they are migrating to. The same needs to be communicated to clients too.

Complexity and risk of the LIBOR re-papering exercise

Rajen Madan
Rajen Madan

The retirement and re-papering of LIBOR poses many risks, including conduct, legal, prudential and regulatory.

Take legal risk. There is a huge amount of legal risk arising from disputes in what interest rates should be paid out in amended agreements referencing alternative reference rates.  The ISDA protocol expected to be published in Q2 2020 should help with, but not solve, these problems.

Similarly, there’s regulatory risk. The PRA and FCA have made clear that they are ‘considering’ the supervisory tools that authorities could use to “encourage the reduction in the stock of legacy LIBOR contracts to an absolute minimum before end-2021.”  This is regulatory code for ‘we will either fine or increase the capital requirements for firms we judge to be dropping the ball’.

Managing legal data requires a mind-set change

A change in mindset and a smarter approach to managing legal data is needed. The historic methodology of most historic re-papering exercises  – i.e. hastily identifying the documents impacted, outsourcing the difficult issues to law firms (at huge cost)and throwing manpower (again at substantial cost) at the problem to handle the contract updates and communications with counter-parties will no longer work. MiFID II is an example. Despite the substantial costs, many financial institutions still don’t meet the deadline.

With regulators continually tightening their grip on financial institutions through reform – and an ever more dynamic global business environment (e.g. LIBOR, Brexit) – it’s time firms acknowledged re-papering as a ‘business as usual’ activity.

Financial institutions need to ensure that LIBOR or any future business re-papering exercise does not compromise client well-being or client experience. For example, to accurately model the financial risk that firms’ portfolios are exposed to via LIBOR when transitioning to a new rate, they need a way to directly link, for instance, multiple cash and derivative contracts to a single client. Additionally, in an environment where most firms are product driven, the scenario of multiple repetitive communications, requests for information and re-papering contract terms looms on the horizon for firms’ customers.

Perhaps for the first time, with LIBOR, firms are looking to develop a long-term vision to create smarter capabilities that will deliver business advantages in the future.

In a recent conversation, Stephanie Vaughan, Global Legal AI Practice Director at iManage RAVN and ex-Allen & Overy, mentioned, “LIBOR is proving to be a real impetus for financial institutions to use technology that, has been available in the marketplace for a long time now. While they may have dabbled with it in the past, due to the scale of the LIBOR remediation and the constantly changing regulatory challenges, it has finally hit home that such projects are a drain on resources and are delivering no business value.”

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Smart data management solutions can help make re-papering ‘business as usual’

A strategic approach to managing legal data requires all stakeholders to come on board – from business units and the compliance department through to legal operations and the General Counsel. This is key to ensuring cross-functional recognition and support for considered directional change.

In a recent industry, financial institutions cited identification of in-scope contracts and the ongoing analytics & management information of their contractual estate for risk management as the two biggest areas they see value in investing in data management solutions.

Thus far, financial institutions have started every re-papering project (e.g. MiFID II, Dodd Frank, and Margin Rules) from square one including undergoing the entire process of determining the clients, what the terms of engagement are, when the contracts expire and so on. Henceforth,  with LIBOR and Brexit, extracting, classifying, storing and maintaining all these data points as structured, base-level information on customers on a single technology platform, will provide firms with capabilities to swiftly understand their exposure, assign priorities and flexibly make contractual changes in accordance with evolving requirements.

This approach is proven. Firms that have comprehensive visibility of their legal contract information via retained structured data, can avoid 80% of the typical re-papering process, and focus their efforts on the remaining, critical, 20% and deploy a risk-based approach.

Financial institutions will then also be well-poised to take advantage of new bolt-on capabilities leveraging artificial intelligence such as enterprise contract generation, search (eDiscovery) and classification, clause management, or real-time analytics. These then, will open the doors to delivering further business value from integration with operational, risk and compliance systems.

 Figure: How can firms take a strategic approach?
Figure: How can firms take a strategic approach?

The opportunity with more effective legal data management is significant and attainable. Building and incrementally strengthening capability through the calculated and proactive use of technology is possibly the only way for financial institutions to adapt to their new regulatory and business environment. Setup of legal reference data functions and effective change management will be pivotal to make this leap.

By Rajen Madan, CEO, Leading Point