"Serious questions" about FCA warning!

Edwin Schooling Latter, director for markets and wholesale policy at the UK’s Financial Conduct Authority apparently said (as reported in Risk.Net)

Not signing these protocols seems to us a huge risk to take if you have effective contracts, and any UK regulated firm with major uncleared derivatives exposures that chooses not to sign will need to be ready for some serious questions from supervisors on how they’re going to mitigate the risks they face.

I have serious questions about that warning. My recent column in the same Risk.Net publication (Signing the LIBOR fallback protocol: a cautionary tale) is implicitly saying exactly the opposite: "any derivative user signing the protocol will need to be ready for some serious questions from its investors".

Just for clarity and again repeating the opinion in my column, I strongly advice derivatives users to sign something related to the fallback. That something should be a bilaterally agreed document with the same intent as the protocol but with the main differences that it is bilateral (not applicable to all adherents) and is signed at a cost (the winner pays the loser). Adopting the fallback language is very different from signing the protocol; the FCA seems to confuse both. The conclusion of my column was:
The best of both worlds would be for parties to agree bilaterally on the signature value, reducing operational and legal costs with an explicit fallback and at the same time obtaining a fair value.

Does the FCA says explicitly that derivative users (and I have in mind asset and pension managers here) don't have obligations to their stakeholder and should sign any derivative legal document as long as it is a "consensus" among derivative dealer?

I will be speaking about this exact issue next week at the Rate Reform conference and the week after at the QuantSummit.

My advice is: don't adhere to the protocol without taking the advice of independent knowledgeable quants on the value transfer implications. If someone blindly advises you to adhere without even looking in details at your portfolio (and running it through in depth analysis fallback tools), he may not understand the economical implication of such an adherence.

If you adhere, you have to be the last one to adhere. By adhering early, you are giving away for free a valuable option to your counterparts. I'm never in favor of being short naked options, here you are short a naked option and you don't even get a premium for it! If you want to adhere to the protocol for some counterparties and sign bilaterally with others, you have first to sign bilaterally and only after sign the protocol, in that order. If you sign the protocol first, your option is gone, for ever!

Note: this is a quant advice, not a legal advice!

21 January 2020

27 February 2020

Added 2020-02-27: The FCA has published today a "Dear CEO letter" to Asset management firms.
The letters says, among other things,
When managing the transition of investments held on behalf of clients, firms should ensure all clients are treated fairly and that their interests are upheld throughout.
Which can only means that the fallback protocol should not be signed blindly, the interest of the client would not be upheld throughout with a signature, only the interest of the legal department of the manager would be upheld.

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