Clare Dawson, Chief Executive – Loan Market Association, Chris Dickens, COO EMEA-HSBC Global Markets, Shaun Kennedy, Group Treasurer-Associated British Ports and Susan Urkevich, Managing Director, COO CFMB and COO C&L-HSBC
Within three years, LIBOR (London Inter-bank Offered Rate – GBP, USD, JPY, CHF) and possibly even several other IBORs (Inter-bank Offered Rates) are expected to cease to exist. As the primary benchmark for determining interest rates for approximately USD350 trillion of financial products1 comprising derivatives, bonds, loans, securitisations and deposits, the potential transition away from LIBOR will be a transformative experience and process for nearly all market participants involved. A panel of industry thought leaders – speaking at HSBC's International Day in London – discussed how the migration from LIBOR to alternative RFRs (risk free rates) will impact corporates.
LIBOR nearing the finish line
Supranational bodies including the FSB (Financial Stability Board) and local regulators such as the UK's FCA (Financial Conduct Authority) have expressed concerns that the interbank lending market, which IBORs are intended to reflect, is no longer sufficiently active or liquid. This regulatory intervention is prompting financial markets to transition away from IBORs towards RFRs or instead change the way in which IBORs are currently determined.
This is an amazing opportunity for corporates to change the way their products work and the benchmarks they use. My personal view is that I will certainly be adopting the new RFRs" said Shaun Kennedy, Group Treasurer-Associated British Ports, speaking at International Day.
1) LIBOR legacy hopes
LIBORs and RFRs have their own distinctive features. Whereas LIBORs utilise submissions supplied by banks, RFRs incorporate transactional data obtained from administrators, which are usually either Central Banks or stock exchanges,2 a set-up that is seen as being less open to misuse. In addition, LIBORs have a forward-looking term structure with a variety of maturities, while the RFRs are so far overnight rates lacking a term structure3. Conscious LIBOR's shelf-life is rapidly expiring, a panellist said corporate treasurers should investigate whether they have hidden LIBOR exposures, and conduct careful risk analysis on how the alternative rates will impact their operations across different currencies and product suites.4
|Currency||Reference Rate||Anticipated replacement||Regulator|
|USD||USD LIBOR*||SOFR (Secured Overnight Financing Rate)||Federal Reserve Bank of New York|
|EUR||EURIBOR||To be confirmed. Alternatives might include a reformed EURIBOR or ESTER (Euro Short Term Rate)||European Central Bank|
|EUR||EONIA (EUR)||ESTER (Euro Short Term Rate)||European Central Bank|
|GBP||GBP LIBOR||Reformed SONIA (Sterling Overnight Index Average)||Bank of England|
|CHF||CHF LIBOR||SARON (Swiss Average Rate Overnight)||Swiss National Bank|
|JPY||JPY LIBOR &
|TONAR (Tokyo Overnight Average Rate)||Bank of Japan|
* The ARRC anticipates SOFR replacing the Effective Federal Funds Rate (EFFR)) as the rate used for discounting and Price Alignment Interest (PAI) in the cleared context beginning Q1 2020.
LIBOR's demise is causing numerous operational challenges for corporate clients, including those with syndicated loan agreements in place. While LIBOR is forward-looking, RFRs' use of overnight rates means loan interest costs may not be known at the beginning of the interest period, raising the possibility that cash-flow uncertainties could emerge5. One speaker pointed out existing loan agreements had not accounted for the cessation of LIBOR, which could result in organisations having to renegotiate the terms of their contracts, or integrate fall-back provisions. Amending these documents will incur costs at corporates.
"This is the single biggest thing that has happened in the loan market for 50 years. It is essential the borrower community makes sure their voices are heard [by engaging with regulators] so it ends up with products that work for them," explained Clare Dawson, Chief Executive – Loan Market Association.
Similar to the upheavals facing syndicated loans, the notion that LIBOR may end one day has not been factored into derivatives agreements either. Again this may create problems for corporates. As the RFRs will behave differently to LIBOR, companies need to think carefully about their hedging strategies to ensure that they are managing risk correctly. Clare Dawson said: "The transition would ultimately force corporate users of derivatives to implement repapering of their underlying agreements – such as credit support annexes – to incorporate various adjustments, and enable seamless continuity for legacy contracts – especially those not due to mature until after 2021 – ahead of the transition to the RFR".
LIBOR legacy hopes
Despite regulators issuing statements highlighting that LIBOR's demise will happen in 2021, many industry participants hope that a synthetic LIBOR could eventually emerge facilitating continuity on some of their legacy contracts. ICE Benchmark Administration – the current LIBOR administrator – is consulting with the banking industry about whether they should publish certain LIBOR settings after 2021 in order to support users with outstanding LIBOR linked contracts that are either impossible or impractical to modify.
One expert urged corporates to avoid complacency, emphasising they should be implementing contingency plans on the basis that LIBOR will not exist after 2021, despite some industry participants suggesting otherwise. While the FCA has not ruled out the idea of a synthetic LIBOR solution to support some legacy contracts, it advised firms in 2018 against relying on the likelihood of this happening, citing regulatory concerns about how different term bank credit spreads could be measured on a dynamic and daily basis under such an arrangement.6
Progress so far
Kennedy said he began implementing plans for LIBOR's discontinuation 18 months ago, and it appears that more organisations are now accelerating their adoption of alternative replacement rates. Referencing FCA figures, Susan Urkevich, Managing Director, COO CFMB and COO C&L-HSBC said: "There had been 15 floating rate bond issuances referencing compounded SONIA (Sterling Overnight Index Average) with a total value of GBP8.7 billion in 2019 alone, exceeding the GBP6.9 billion issued during the previous six months"7. Positive changes are visible in the derivatives markets too, with the monthly average volumes of SONIA cleared OTC contracts increasing by 100 per cent in 2018. With more firms embracing SONIA, liquidity on the RFR is likely to expand further.
While uncertainties do remain about what will happen after 2021, a number of industry associations are working diligently to help with many of these obstacles. A speaker said: "It is imperative treasurers participate in these industry associations' working groups and have frequent dialogues with regulators to ensure the process is managed smoothly". The move onto alternative benchmark rates will introduce added costs and administrative challenges for corporate users of financial products, but the transition can be expedited and accomplished effectively if firms leverage the expertise and services of their banking partners. "Banks are a useful source of information and corporates should leverage them," concluded Chris Dickens, COO EMEA-HSBC Global Markets.
1Risk (October 15, 2018) The USD350 trillion problem: Too big to solve
2HSBC GBM – IBOR Transition
3HSBC GBM – IBOR Transition
4HSBC GBM – IBOR Transition
5PwC (February 2018) Are these the last days of LIBOR?
6FCA (July 7, 2018) Interest rate benchmark reform: transition to a world without LIBOR