Some say only two things in life are guaranteed: death and taxes. But I say there are actually three: death, taxes and the end of LIBOR; everyone in the financial services industry needs to be aware that the date when the existence of LIBOR can no longer be guaranteed is fast approaching.”
- John Williams, President and CEO, Federal Reserve Bank of New York, September 2019
The birth of an Index:
London Interbank Offered Rate (LIBOR) and other Interbank Offered Rates (IBOR) have been a cornerstone for the debt transactions of many financial institutions and corporations for decades. In recent years regulators have made replacing IBORs a priority, particularly as a result of the credibility and reliability challenges that followed the 2008 financial crisis. The Financial Conduct Authority has made it clear that it will no longer compel banks to submit quotes for LIBOR from the end of 2021 and that it is not advisable to rely on LIBOR being available thereafter.
As alternatives to IBORs, the U.K., the European Union, Switzerland, Japan, and the U.S. have all developed alternative reference rates (ARRs). In recent months, they have started to make these available for use.
How to Update $400 Trillion in Contracts for LIBOR Transition ?? Time is running out..
There are many risks to doing nothing. For borrowers, their loan terms could become dated or faulty.
(1) They may incur increased financial costs or experience cashflow fluctuations. For investors in LIBORbased debt instruments (including floating rate debt, bank loans, LIBOR-linked derivatives, some assetbacked securities), the value of their investments may become unclear thus harder to sell or trade.
(2) And for banks that issue debt or loans they open themselves up to potential regulatory fines, litigation, negative press, reputational damage and loss of business.
(3) only 20 percent of organizations report they are functionally prepared to move away from LIBOR, and 40 percent point to regulatory ambiguity on reference rates as reasons for inaction. Transitioning from LIBOR is a critical, complex challenge for banks, capital markets, corporates and insurance firms, but there’s a general lack of preparation among these groups.
Three Point Plan for an Efficient Transition
For debt issuers with transactions that reference LIBOR or other IBORs, here is a three-point plan for an efficient transition:
Work with their advisors to identify appropriate successor ARRs and any adjustment calculations, and then determine any necessary document amendments.
Establish what level of consent is needed from noteholders to approve the proposed benchmark updates. While some issuers may already have robust fallback provisions built into their transactions, others will require consent from noteholders to make any changes required for the transitions to ARRs.
Make a plan to ensure a smooth transition. In cases where noteholder approvals are required and where issuers must solicit consent, they will need to pass notifications to noteholders through the custody chain.
Article published by GARP can be downloaded here:
What this means for banks:
- Assess the universe of contracts and get organized
- Analyze and categorize
- Ensure security and confidentiality
- Determine if fallback terms or alternative reference rates, when applied, disproportionately benefit one party over another
- Collaborate with clients and stakeholders
- Centralize and ensure secure communication channels