Fair LIBOR transition: How low is the regulators' bar?

IBOR transitions (mainly LIBOR transition for the moment) is a huge undertaking for the derivative markets. It implicates many market participants, from large dealer/broker to small end users. Everybody want the transition to be perceived as "fair".

Reading trough the regulator published notes, FAQ and letters, I notice that I don't have the same definition of "fair" than some regulators. This leads to my question in the title: How low is the regulators' bar?

To illustrate my point, I will take two examples, one from the FCA and one from the CFTC.

The italic texts below are extracts from the regulators and ISDA documents, the regular text are my comments.

FCA

The FCA published a "Questions and answers for firms about conduct risk during LIBOR transition".

Treating customers fairly when replacing LIBOR LIBOR discontinuation should not be used to move customers with continuing contracts to replacement rates that are expected to be higher than what LIBOR would have been, or otherwise introduce inferior terms.

I fully agree with this, to be fair the terms have to be "not inferior".

Firms are more likely to be able to demonstrate they have fulfilled their duty to treat customers fairly where they adopt a replacement rate that aligns with the established market consensus, reached through appropriate consultation, and is recognised by relevant national working groups as an appropriate solution.

Here I have a strong disagreement. The consensus are legal wording consensus on mechanisms that are perceived as working from an operational point of view — as you know, I even disagree with the fact that it is actually operational, but for this post I stop at "perceived" — and that can be incorporated in new contracts. It is fair for new contracts in the narrow sense that parties know the contract terms and can price it accordingly. In that sense a fallback to a benchmark that reference the amount of snow in London (and not a interbank rate) would also be fair: participants know the terms, they can price them. The market consensus is a legal wording for new trades, not a fairness test for replacement in continuing contracts. Not even ISDA claims it is fair for replacement in those contracts. In a May 2019 comment, Scott O'Malia, ISDA's CEO, said

That doesn’t mean the adjusted RFR will exactly match the relevant IBOR – it won’t, so there will be winners and losers.

And the FCA to continue with

ISDA’s work on fallback rates has identified a broad consensus for calculating a fair replacement rate in LIBOR derivatives, receiving substantial support across the market, including both payers and receivers of floating rates.

No, there is no consensus on the fairness of the replacement rate. As mentioned above, if there is a consensus, it is that the replacement is not fair in term of value transfer. It is an acceptable mechanism as fallback wording for the majority to be used in new trades.

In my answer to previous ISDA consultations, I proposed that each respondent indicates the sensitivity of its institution for the proposed spread mechanism. This would have allowed to see how much conflict of interest there was among the respondents and could be used a transparency mechanism. My suggestion was unfortunately not implemented.  How does the FCA know if the respondents were payers or receivers of Ibor rates? Can the FCA provide a detail analysis of its above claim about "receiving substantial support across the market, including both payers and receivers of floating rates"? I have not seen any data about this. Maybe, for the sake of transparency, FCA could provide the data underlying this claim.

CFTC

CFTC published a no-action letter for transition (CFTC Letter No. 19-26 No-Action December 17, 2019).

The letter contains a section about

	SD (Swap Dealer) Business Conduct Requirements
	the SD may not be able to reasonably determine that the counterparty is capable of independently evaluating investment risks with regard to the amendment.
	DSIO (Division of Swap Dealer and Intermediary Oversight) therefore believes SDs should be required to provide material information about such new rates in order for counterparties to better understand what they are stepping into.
	DSIO will not recommend that the Commission take an enforcement action against an SD for a failure to comply with the Counterparty BCS (other than Commission regulation 23.431(a)) solely to the extent such compliance would be required as a consequence of a Qualifying Amendment to an uncleared swap.

My understanding of the above is that if a SD proposes to a client to sign the ISDA fallback protocol and provides him material information about SOFR and compounding, it will be protected by the no-action letter. This protection is valid even if the adjusted RFR and the adjustment spread resulting from the protocol are far apart from the fair interbank rate on the fixing date. To me the least that a SD should provide to its counterparty is an estimate of the fair value of LIBOR instruments in absence of transition and the monetary impact of the changes (fallback wording, new rate/spread, protocol, clearing, etc.)

Low bar?

In both cases, the bar about the conduct appears to me very low. This is a strong incentive to collude / create a consensus against end users.

It sounds like "As long that there is a consensus among bandits on the way the robbery should occur, it will be considered as fair to the victims and no-action from law enforcement is required".