Co-authored by Axel Eissen and Babken Hakobyan.
Global interest rate benchmarks such as the Interbank Offered Rates or IBORs have long been the cornerstone of the financial industry with trillions of dollars of financial products attached to them. These are essentially floating rates based on actual or estimated interbank offering rates for short-term loans.
Recent market volatility and declining liquidity in the unsecured interbank lending market have necessitated the search for alternative rates and benchmarks that can adhere to the official International Organization of Securities Commissions (IOSCO) principles for financial benchmarks.
By 2021, currently known and used rates for both (IBORs) and overnight interest will be replaced by new, transaction-based and risk-free reference interest rates (RFRs) and alternative replacement rates (ARRs). This means that financial institutions now must rapidly adapt their contractual arrangements to fill the gap that IBOR replacement will create, which have been used extensively for many products – both in capital markets and in classic consumer/retail banking such as for deposits and lending. This will mainly impact contracts relating to products, customer and counterparties that extend beyond 2021, especially long-term framework agreements with customers or counterparties in particular.
Managing the Shift
Financial institutions are currently working on implementing the changeover from IBOR to RFRs – managed internally or with the help of external resources. In contrast to previous regulatory changes, however, the adjustment requirements no longer relate only to individual products or product groups in the capital market-related area. Rather, there is a need to identify and, if necessary, adjust affected contracts across all business areas of a financial institution.
In practice, what makes this particularly challenging is that the individual business areas operate largely independently of each other by using area-specific applications and guidelines for the documentation and archiving of contracts. Many of these are different and often disconnected IT archiving applications which have grown over several decades, and are partly outdated.
IBOR replacement: A wake-up call for the industry?
The cost-driving obstacles of the implementation of the IBOR replacement lie less in the technical and legally correct analysis and adjustment of the contracts, but rather in the time and resource-intensive, largely manual compilation and capturing/storing of all affected contracts in advance, which is paramount.
The lack of a cross-departmental and digital contract management system requires complex coordination processes between the departments. In addition, due to the technical diversity of the divisions, the staff involved either require broader specialist knowledge or the involvement of appropriate specialists – both of which lead to rising personnel costs and thus to higher complexity costs of the transformation.
Currently, financial institutions are primarily concerned with the digitization of their business models and therefore with the process and product-oriented adaptation of their IT infrastructure. However, the current example of the IBOR replacement illustrates the necessity of setting up a digital, centralized contract management system as a basis for further operations.
This change in the market should be seen as an opportunity to invest in a future-ready environment that minimizes both time and effort for accessing contract content and thus can additionally have a positive impact on overall operational efficiency.
Overcoming the Barriers to Centralization
Due to the potential complexity and incompatibility of IT systems, cross-departmental networking of all old systems must be ruled out as a solution. Alternatively, connecting individual systems via interfaces to a central, newly introduced contract management tool also poses challenges due to commonly found fragmented system landscapes with multiple programming languages. Linking the existing systems to a new solution during ongoing business operations include the risk of system failures and/or data loss.
To mitigate these risks, introducing a contract database as a layer between the existing IT infrastructure and a new contract management tool, connected via interfaces could be a viable option. This can also be supplemented by capturing additional contract documents that have not yet been digitized.
Linking this data lake to a contract management software would then make it possible to transfer contract data into a uniform format and generate viable benefits from clustering, analyzing or extracting the datasets. Affected departments would be granted a tailored access right to the contract management tool to initially query and later directly enter data and carry out the sector-specific analysis.
Laying the Foundation for AI and RPA
A company-wide, centralized digitization approach for all contracts is the perfect base to leverage cutting-edge technology such as artificial intelligence and RPA.
Taking the scope beyond pure archiving and easy-to-use access options, an AI-enabled self-learning system, powered by bots can minimize human errors, time consumption and costs, and maximize the efficiency of repetitive activities by creating new clusters of contracts in the areas of customers, counterparties or products. Automation of repetitive and manual activities will also enable legal experts to concentrate on managing complex contracts.
This, in turn, will generate new business intelligence insights, improve results for regulatory requirements such as KYC and increase in-house benchmarking capabilities. We are already seeing the first variants of AI-based contract analysis tools on the market such as the Infosys NIA contract analyzer tool.
In our view, the digitization of contract management is a clear enabler for success and the key to unlocking new business opportunities. Investment in the central digitization of contract management should, therefore, be an essential component of a holistic digitization strategy that can catapult a financial organization way ahead of their competition.
Associate Partner, Infosys Consulting
Daniela has more than 18 years of experience in the banking industry and heads up our capital markets business in Germany. She joined Infosys Consulting in 2017 from Sopra Steria Consulting where she was a business unit manager and prior to that, she was a director at SQS. Daniela started her career as a banker, working for LBBW and Dresdner Kleinwort Wasserstein, before moving to consultancy.
Principal Consultant, Infosys Consulting
Axel Eissen is part of our financial services practice in Germany and is focused on capital markets. He has extensive consulting experience within the regulatory reporting and financial services domain. Before joining the consultancy area, he worked as an equity trader for many years and is a seasoned expert in trading, products and processes. Axel holds a diploma in business administration from the WWU Münster and is PRINCE2 and PRINCE2 Agile certified.
Senior Consultant, Infosys Consulting
Babken Hakobyan is a capital markets, risk management and regulatory reporting expert. He has enabled several leading financial institutions to comply with new regulatory requirements, build reliable reporting solutions, and optimize their processes and data management infrastructure. He joined our financial services practice in 2018 and is part of our capital markets team. He started his consulting career in 2014 with ZEB consulting and has since worked with several top financial data providers and financial services firms. He holds a master’s degree in finance and Information management from Goethe-University Frankfurt am Main.