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Banks turn to AI as regulators press for Libor exit

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Frequently described as the world’s most important number because it underpins trillions of dollars of transactions, the London interbank offered rate (Libor) has persisted until now despite a scandal that caused lasting reputational damage to the entire financial system.

Libor is the key interest rate benchmark for mortgages, loans and contracts but it has been tainted since 2012 when it emerged that banks had misstated their Libor rate submissions, often in collusion, to make better returns. 

The controversy led to at least five traders going to jail in the UK, and US and UK regulators extracting penalties totalling about $10bn. Regulators want Libor phased out by December 31 2021, and banks are pivoting to alternative risk-free rates such as Sonia (sterling overnight interbank average rate).

Its demise is already a headache for law firms and banking clients, which must examine hundreds of thousands of legal contracts containing references to the Libor rate and then rewrite and “repaper” them to ensure they include the new reference rates. Contracts must also be analysed for “fallbacks”, the legal rules that spell out what would happen if Libor ceased to exist. 

‘Defcon 1 litigation event’

The scale of the repapering exercise is dubbed “immense” by those involved and last year was publicly described as a potential “Defcon 1 litigation event” by Michael Held, general counsel at the New York Federal Reserve.

This has led many law firms and their bank clients to turn to artificial intelligence (AI) technology, often provided by start-ups, which can review large numbers of documents using natural-language processing to identify legal clauses and obligations. Harnessing technology to do the grunt work means banks can avoid paying for armies of sleep-deprived junior lawyers and paralegals to sift through contracts, which in some cases may still be paper documents.

“It is possible to train AI to look for Libor or how Libor is referenced in various guises and to do that in various languages,” says Deepak Sitlani, head of the derivatives and structured products group at law firm Linklaters in London, who says some clients have developed their own technology tools.

“This is taking up a lot of resources and if you are a bank it’s a massive project,” says Adam Ryan, chief legal innovation officer at law firm Freshfields.

Lewis Liu, chief executive of Eigen Technologies, a natural-language processing company that works with banks such as ING and Goldman Sachs, estimates that about half its work this year is from clients using technology to help ease the switch from Libor.

Eigen’s technology helps automate the process of finding and flagging the contracts and then identifying the types of remediation needed. However, the technology cannot write a new contract or carry out repapering work.

No more grunt work: Eigen Technologies uses artificial intelligence to search contracts for references to Libor

Mr Liu says banks are at different stages of readiness, despite the regulators urging them to make progress on leaving Libor. “I know of one big US investment bank [that] has completed its programme and another bank [that] has not yet started the work,” he says. One bank has even opted to review contracts manually with the help of lawyers rather than use technology.

For a large wholesale bank, he estimates, it could take 1,000 lawyers more than two years to identify and switch over all its contracts manually, whereas technology can do this in four months with 20 paralegals and lawyers. The attraction is not just speed, he adds: “Banks are using it as an opportunity to do large-scale digitalisation of their documents,” he says.

In the past few years AI has been deployed in litigation cases to help large companies scan databases or email archives to find a particular word or search term, and then apply relevant changes. 

Charlie Connor, chief executive and co-founder of US-based Heretik, says machine learning is being used in a sophisticated way for the Libor transition.

It enables a 700-page Libor contract to be searched and even to pick up punctuation and the part of the sentence that would determine the remediation strategy. Contract disputes in the past have turned on punctuation such as a misplaced Oxford comma — a mark that comes before the “and” or “or” at the end of a list but which can change the meaning of a sentence.

Mr Connor says the Libor transition is making banks digitise paper contracts that might be scattered in various offices. “Banks and financial institutions are being forced into digitisation through Libor and can see its benefits,” says Mr Connor. “The software is very effective and it means law firms will be doing less mundane tasks and more higher-quality work, which is what counsel is paid for.”

He says doing this work now means that the same AI technology can be used to examine contracts en masse for other financial risk factors, such as negative interest rates. “You can run it to look at the effect of negative interest rates which could be impacted by, for example, Brexit,” he says.

Some lawyers suggest that while the biggest effect of the Libor transition will be on leading banks, other non-financial services companies could also be involved if they use Libor-related business contracts to buy and sell goods, for instance, for late-payment clauses or cost increases in long-dated contracts.

If no replacement for the Libor rate has been specified in a contract, the two parties would then have to decide what other benchmark to use. “If there is money involved there might be a fight about it,” says one lawyer, who declines to be named. He also suggests that banks could start to use the replacement of Libor as an opportunity to reopen older contracts with customers and renegotiate other terms.

For now, it is clear that the task of extracting the industry from using Libor cannot be left by banks and corporates till next year, even if they are already grappling with more immediate priorities such as the coronavirus pandemic and the departure of the UK from the EU.

The case studies below are a shortlist of entries to the FT Intelligent Business awards event held online on November 19, where the winner of the Financial Services award was announced.

All the entries showcase the combined use of data and tech in business operations. Source: RSG Consulting

Financial services

© Alamy Stock Photo

WINNER:
ING Bank and Eigen Technologies

In 2020, Dutch bank ING launched its Saber Data Extraction Platform, which uses natural-language processing technology from artificial intelligence company Eigen Technologies to extract information from documents. The platform accounts for the nuances and inconsistencies in human language and was first used in ING’s interbank offered rate (Ibor) benchmark transition.

Of thousands of documents reviewed, 80 per cent required no further review and there was a 75 per cent reduction in overall review time. ING Bank and Eigen Technologies estimate their collaboration cut the cost of this review process by 60 per cent.

D2 Legal Technology

A number of investment banks have implemented the legal data consultancy’s new tech-enabled due diligence service to identify its counterparty in regulatory capital calculations. Previously, experts in investment banks would conduct this research independently, even though many were searching for the same information.

By offering this service to banks, D2 Legal Technology has built a global database with the information, completing anonymous searches. D2 says the solution reduces the cost of the process by half. 

Dürr and Targens

Dürr, a mechanical and plant engineering company, last year raised a €750m syndicated loan with the support of 13 international banks. The loan was raised through a blockchain platform developed in-house, using a service from Targens, a German consultancy, that creates digital identities for business-to-business transactions. Raising a loan digitally reduces the time required to establish legally binding contracts with multiple parties.

NatWest and Nuance Communications

NatWest bank fields 17m calls from customers every year. For security checks on these calls, the bank previously relied on “static” data for identification (such as addresses or mother’s maiden name), but such details are easily stolen online. The bank’s fraud-prevention team is using voice recognition technology created by AI company Nuance Communications to catch known fraudsters impersonating customers.

NatWest is starting to use biometric data to identify customers, removing the need for static data. Through its use of a variety of technology, the fraud-prevention team spots fraud before customers do in 80 per cent of cases.

Financial Services category research and award supported by Ashurst



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ExxonMobil proposes carbon storage plan for Texas port

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ExxonMobil is pitching a plan to capture and store carbon dioxide emitted by industrial facilities around Houston that it said could attract $100bn in investment if the Biden administration put a price on the greenhouse gas.

The oil supermajor is touting the scheme ahead of the US climate summit starting on Thursday, where President Joe Biden plans to announce more aggressive national emissions targets and hopes to spur world leaders to increase their own carbon-cutting goals.

Carbon capture and storage, or CCS, “should be a key part of the US strategy for meeting its Paris goals and included as part of the administration’s upcoming Nationally Determined Contributions”, said Joe Blommaert, head of Exxon’s low-carbon focused business, referring to the targets that countries are required to submit under the 2015 Paris climate agreement.

Oil and gas producers have sought to highlight their commitments to tackle emissions ahead of this week’s climate talks, which promise to heap pressure on the fossil fuel industry. BP pledged to stop flaring natural gas in Texas’ Permian oilfields by 2025, while EQT, the country’s largest natural gas producer, said it backed federal methane regulations.

The International Energy Agency has called carbon capture and storage, which uses chemicals to strip carbon dioxide from industrial emissions, “critical for putting energy systems around the world on a sustainable path”.

But the technology has struggled to gain traction as costs have remained persistently high. The most recent setback in the US came last year with the mothballing of the Petra Nova project, the country’s largest, which captured carbon from a Texas coal-fired power plant.

Many environmental groups have been critical of the oil and gas industry’s focus on carbon capture, arguing it is used to justify continued investment in oil and gas production and is not economical, especially as the costs of zero-carbon wind and solar power have plummeted.

Exxon said that establishing a market price on carbon — which has been attempted by a handful of US states, Texas not among them — would be important. The US government should “implement policies to enable CCS to receive direct investment and incentives similar to those available to other efforts to reduce emissions”, Blommaert said.

Exxon declined to comment on the carbon price it thought was needed to justify the investment, but said its plan would generate $100bn of investment from companies and government in the Houston region.

The company’s plans call for a hub that would capture emissions from the 50 largest emitting industrial facilities along the Houston Ship Channel, such as oil refineries and petrochemical plants, and ship the carbon by pipeline to reservoirs for storage deep under the sea floor of the Gulf of Mexico.

The project could capture and store about 100m tonnes of CO2 a year by 2040 if developed, Exxon said. That is 2 per cent of the roughly 4.6bn tonnes of US energy-related carbon emissions in 2020, according to the Energy Information Administration.

Exxon has been under intense pressure from investors, including a proxy fight with the activist hedge fund Engine No 1, to bolster its strategy for the transition to cleaner fuels. In February, it created a low-carbon business line that it said would spend about $3bn over the next five years.

Biden’s $2tn clean-energy focused infrastructure plan would expand carbon capture and storage tax credits. The administration said it would back 10 projects focused on capturing carbon from heavy industry, but it did not endorse a price on carbon.

Climate Capital

Where climate change meets business, markets and politics. Explore the FT’s coverage here 



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European stocks hit record after strong US earnings and economic data

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European equities hovered around record levels, the dollar dropped and government bonds nudged higher on Monday as markets continued to cheer strong economic data while also banking on continued support from the US Federal Reserve.

The regional Stoxx Europe 600 index gained 0.3 per cent during the morning to set a new record, before falling back to trade flat.

This follows a week of upbeat earnings from US banks as investors await results from big businesses including Coca-Cola and IBM later on Monday. Data released last week showed US homebuilding surged to a near 15-year high in March while retail sales increased by the most in 10 months.

The dollar, as measured against a basket of currencies, fell 0.4 per cent as bets on higher interest rates receded. The euro rose 0.4 per cent against the dollar to buy at $1.203. Sterling also gained 0.4 per cent to €1.389.

Federal Reserve chair Jay Powell told the Economic Club of Washington DC last week that the central bank would not taper its $120bn of monthly asset purchases until it saw “substantial further progress” towards full employment.

Haven assets such as government debt remained in demand. As prices ticked up, the yield on the benchmark 10-year US Treasury note fell 0.02 percentage points to 1.557 per cent, while the yield on the equivalent German Bund slid 0.01 percentage points to minus 0.271 per cent.

Investing convention assumes that US Treasuries and global equities move in opposite directions to cushion against falls in either asset class, but both have now rallied in tandem for an unusually sustained period.

The S&P 500, the blue-chip US stock index, has risen for four consecutive weeks to set new records. The yield on the 10-year Treasury has fallen from about 1.74 per cent at the end of March to just under 1.56 per cent on Monday as investors bought the debt. Treasuries and US stocks not have risen together for so long since 2008, according to Deutsche Bank.

Futures markets indicated the S&P would drift 0.2 per cent lower as Wall Street trading opens.

“I am not saying it’s a rational time in the markets,” said Yuko Takano, equity fund manager at Newton Investment Management. A reason for caution, she added, was signs of “bubbles” in alternative assets such as cryptocurrencies and non-fungible tokens. “There is really an abundance of liquidity. There will be a correction at some point but it is hard to time when it will come.”

“Markets may have become temporarily overbought,” strategists at Credit Suisse commented. “For now, we prefer to keep equity allocations at neutral” rather than buying more stocks, they said.

In Asia, Hong Kong’s Hang Seng index closed up 0.5 per cent and Japan’s Topix slid 0.2 per cent.

Global oil benchmark Brent crude fell 0.3 per cent to $66.57 a barrel.



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EU split over delay to decision on classing gas as green investment

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The European Commission is split over whether to postpone a decision on classifying gas generated from fossil fuels as green energy under its landmark classification system for investors.

Brussels had planned to publish an updated draft of a taxonomy for sustainable finance later this week. The document is designed to guide those who want to direct their money into environmentally friendly investments, and help stamp out the misreporting of companies’ environmental impact, known as greenwashing. 

The commission was forced to revamp its initial proposals earlier this year after the text was criticised by member states which want gas to be explicitly recognised as a low-emission technology that can help the EU meet its goal of becoming a net-zero polluter by 2050. 

Now the publication of the draft rules could be postponed again as the commission seeks to resolve the impasse. According to a draft of the text seen by the Financial Times, the commission proposed to delay the decision in order to carry out a separate assessment of how gas and nuclear “contribute to decarbonisation” to allow for a more “transparent” debate about the technologies.

But officials told the FT that some commissioners were pushing for gas to be awarded the green label now, rather than delaying the decision until later this year. 

“There are a sizeable number of voices in the commission who want gas to be included in the taxonomy,” said one official. A final decision on whether to approve the current text or delay it again for further redrafting is likely to be made on Monday.

The EU’s taxonomy is being closely watched by investors as the first big attempt by a leading regulatory body to create a labelling scheme that will help guide billions of euros of investment into green financial products.

But the process has proved divisive, as several EU governments have demanded recognition for lower-emissions energy sources such as gas. 

Coal-reliant countries such as Poland, Hungary, Romania and others that are banking on gas to help reduce their emissions do not want the labelling system to discriminate against them. France and the Czech Republic, meanwhile, are also pushing for the recognition of nuclear as a “transitional” technology in the taxonomy.

A leaked legal text seen by the FT earlier this month paved the way for gas to be considered green in some limited circumstances. That has since been removed along with other sensitive topics such as how best to classify the agricultural sector, according to the latest draft the FT has seen.

EU governments and the European Parliament have the power to block the draft if they can muster a qualified majority of countries and MEPs against it. 

Environmental groups have hailed the exercise, and urged Brussels to stick to science-based criteria in defining the thresholds for sustainable economic activity.

Luca Bonaccorsi from the Transport & Environment NGO said delaying decisions on gas and nuclear risked allowing pro-nuclear countries like France and the Czech Republic to join up with pro-gas member states “to forge an alliance that will obtain the greening and inclusion of both energy sources”.

“Should they ally, it will be impossible to resist the greenwashing of these two unsustainable energy sources,” said Bonaccorsi. 

The delays in agreeing the taxonomy have forced Brussels to abandon an attempt to use it as the basis for EU green bonds that will be issued as part of the bloc’s €800bn recovery and resilience fund. About €250bn of debt will be issued in the form of sustainable bonds over the next few years, which will make the commission one of the world’s biggest issuers of sustainable debt.



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