Rate of change

LIBOR is on its way out – but deciding what will replace it and smoothing the transition is no small task.

In a world where banks have largely turned away from term unsecured interbank funding as a source for funding their own operations, LIBOR’S instability, it was felt, made it unsuited for a financial system changed by the 2008 financial crisis.

Calls to reform LIBOR were eventually heard, with regulators confirming that the rate would gradually be phased out over a four-and-half-year period. And the message from a recent Association of Corporate Treasurers (ACT) panel session on the subject was clear: the transition will be a challenge.

Watch delegates speaking at ACT’s panel session from International Treasury Week.

“LIBOR has been deeply embedded in our system for a long time, so it’s a big change,” said Edwin Schooling Latter, director of markets and wholesale policy at the Financial Conduct Authority (FCA), the body charged with leading the transition.

“How banks treat their customers is the raison d’être of the FCA and in this transition from LIBOR to more robust benchmarks we need to be sure that all parties are confident that the end result is of benefit to them and that all involved are confident that they are being treated fairly – that’s central to what we’ve been doing,” he said, adding that a smooth transition has also taken up much of the work of the Risk Free Rate Working Group, the combined public-private taskforce that has led the effort in the UK.

Next steps

So what next? What will replace LIBOR? So far, there is a range of overnight risk-free rates that have been identified by market groups in the five LIBOR currencies – the UK’s pound sterling, the US dollar, the euro, the Japanese yen and and the Swiss franc. The UK’s preferred replacement to LIBOR is SONIA, or the Sterling Overnight Index Average.

And that represents a sea change for the banks. As someone who has, for the last year, acted as a LIBOR transition lead, Jamie Thrower, head of syndicated loans agency and LIBOR transition business lead at NatWest, has held responsibility to design, set and implement a strategy to develop new products to work with bankers and clients to help transition the existing LIBOR book.

Treasurers really need to understand what their legacy exposure to LIBOR is – whether that’s your derivatives, hedging or treasury management systems

Edwin Schooling Latter
Director, markets and wholesale policy, FCA

The transition will affect every aspect of the financial system, from bonds to loans and all points in between.

“The changes are driven by the participants in those markets,” said Thrower. “And in the loan market, for instance, you have a broad set of participants and a very flexible set of products. And it’s a private market – so where the loan market lacks an overriding body that sets the standards progress towards a consensus view is more challenging.”

Pushing for change

So what’s blocking change? Thrower explained: “There are a few things: there is still confusion over the method of calculation, with different methodologies available and each having their own merits. What we’ve tried to do is to look at more mature markets such as bonds and derivatives to see what they’ve done, and at NatWest we’ve lent heavily on best practice elsewhere.”

Thrower pointed out that confidence is key. “On both the sell side and buy side, to branch out and do something on a bilateral basis and back your own judgement and assessment that you’ve got the right answer, takes a lot of bravery. With markets famed for their herd-like instincts it can take a leap of faith.”

Beyond that, Thrower believes there is a limited level of practical experience on the lending, borrowing and advisory side – also slowing down the transition period and the development of alternative benchmarks.

“Knowledge develops in all kinds of ways, not only theoretically, but also practically: so when you’re working with a borrower who wants to achieve something new and a number of banks motivated to meet that need, most of the parties in that transaction are doing so for the first time, be they lawyers, advisers or lenders, and that slows things down. The market needs a greater volume of deals in order to raise education and understanding and thereby create a more liquid market.”

Taking the lead

So how will this affect corporate treasurers concerned about the disruption brought about by the changes? There’s no doubt that while the transition away from LIBOR is presenting all kinds of challenges to borrowers, lenders and regulators, it does, however, offer banks the chance to look at their product set and do a thorough audit of whether they are meeting clients’ needs.

“Do we need to offer five or six separate products or can we meet clients’ needs much more simply than that?” Thrower asked. “There is a sense that we’ve become a little overcomplicated; perhaps there is a type of customer need that can be met by a base rate-linked facility going forward, rather than a SONIA facility.”

One of the measures NatWest has taken is to raise the threshold for LIBOR lending such that smaller borrowing requirements are met instead with a base rate-linked product, something that Thrower expects others to adopt in the market as time goes on. Taking such steps now will help to ensure that all participants are ready, a key message that resonated across the panel session.

“Everyone should be universally aligned towards avoiding waking up on 1 January 2022 and finding that they have a set of products, instruments and contracts that they don’t know how to operate anymore,” he added.

Good housekeeping

Indeed David McNally, IBOR transition director at Deutsche Bank agreed, and urged treasurers to use the time left to make sure they understood their exposures and what trends were emerging on the lending side.

“Call your bankers, make sure you take action to get ready,” he said. And that means adopting a proactive, collegiate approach.

“This isn’t a ‘bank problem’ that will be solved and presented to you,” concluded Thrower. “This is something that all of us need to work on together in order to meet the milestones to develop confidence that we’re on the right path to transition. There will be friction, but don’t assume that the bankers have the monopoly on knowledge – take ownership and get stuck in.”

Schooling Latter enthusiastically endorsed Thrower’s call: “Treasurers really need to understand what their legacy exposure to LIBOR is – whether that’s your derivatives, hedging or treasury management systems – and when you’ve done that stock take of what that looks like, devise a plan to make sure that all of those are robust to the discontinuation of LIBOR,” he said.

“Often the best answer will be converting those before the end of 2021; sometimes it might be relying on a fall back – but whatever it is don’t be left without a plan on New Year’s Eve 2021.”

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