As 2021 has drawn to a close, the transition away from the London Interbank Offered Rate (LIBOR) is at full speed. Outside the firms concentrated on USD rates, financial institutions have ended legacy LIBOR products. Sterling, Euro, and yen-based LIBOR products, as well as the issuance of new products based on rates such as SONIA (Sterling Overnight Interbank Average Rate) are well under way. Hiccups have been observed among treasury and core product accounting systems, methodology readiness to blanket adjustment collateral valuations and client outreach during the transition of non-USD LIBOR. But skilled and swift remediation by both financial institutions and corporates have led to a relatively smooth transition.
And though “things did not get out of hand,” and the transition is progressing at full speed, the message to those driving the changeover continues to be: Do not take your foot off the gas pedal as there is still a lot of ground to cover.
The USD remains a major concern. Although the phase-out of USD LIBOR is not scheduled until June 2023, as of January 3rd, 2022, there are to be no new USD LIBOR originations. There is expected to be intense focus on the remaining USD-based products and – the three, six, 12 and 24-month USD LIBOR, JPY and Sterling tenors on synthetic LIBOR (one-, three-, six month) products that have yet to be converted to alternative rates. Financial services firms, as well as corporates, are encouraged to be hard at work getting ready for the issuance of products based on SOFR (Secured Overnight Financing Rate), Credit Sensitive Rates (CSRs) and American Interbank Offered Rate (AMERIBOR®).
With the shift away from LIBOR, institutions can expect increased regulatory oversight of their conversion progress, including their risk management capacity, capital adequacy and general readiness to handle change. Financial services firms can expect to receive the most scrutiny. As we noted in recent research, issuing banks and other institutions that originate loans, credits and other LIBOR-based transaction contracts have already spent time and effort on operational readiness and client transition in preparation for the June 2023 USD cessation.
Corporate and consumer clients have been slower to transition. The recent emphasis on operations and front office readiness, however, may mean that the second line of defense and other corporate functions are tested in areas including capital and liquidity risk management. By and large, issuers have identified affected instruments, updated operations, contacted clients, amended contracts, and made necessary adjustments to internal systems, including developing new statements, and charging the correct interest rates going forward.
For financial services firms and corporates, they need to maintain focus on operationalizing fallbacks, implementing a scalable operating model to understand the impacts of each issuer’s offer, complying with investment mandates and contractual covenants, and establishing new methods for managing portfolio performance. This may involve digitizing legal processes and activating plans drawn up many months ago. These institutions need to make sure that: a) operational transitions run smoothly, avoiding reputational risks; and b) customer relationships remain unruffled, with customers incurring no out-of-pocket costs. While the bulk of this work was to be completed for non-USD, non-JPY and non-Sterling synthetic rate products by December 31st, there may be some loose ends to tie up.
For financial services firms and corporates, tasks related to client readiness, outreach and education are expected to continue. Borrowing rates on consumer instruments such as mortgages, for example, are expected to change, requiring new explanatory materials and possible staff retraining. Corporates need to continue analyzing scenarios to understand the impact of the transition upon in-house cash, treasury, and funding functions.
There are larger strategic issues to address, as well. Financial services firms need to rethink their financing and capital acquisition plans, not just in light of the move away from LIBOR, but in the context of new workforce realities, supply chain challenges, and the disruption posed by non-traditional market entrants. LIBOR transition activities can serve as the lever to effect other needed changes.
With this in mind, firms are strongly encouraged to keep a sharp lookout for market movement in the following areas:
- Level of client readiness. Are client inquiries up? Are they expressing unexpected concerns?
- Emerging operational impacts and surprises. Have you planned for the most likely and unlikely scenarios?
- Depth, turnover and velocity of rate products like swaps. How can these adversely affect your business?
- Acceleration of bond and loan syndication issuances. Are these exposing you to unexpected new risks?
- Hiccups in liquidity and capital stress testing and annual cycles. Is your organization able to respond with confidence?
As each firm’s situation is unique, here are some general guidelines for navigating the next 18 months:
- Improve collaboration across internal teams and transition vendors to access all relevant skills.
- Select vendors for transition activities, including trading platform technologies and legal third-party alliances, and get all parties onboarded.
- Develop “industrial strength” integrated solutions across business lines, people, process, and technology and apply these solutions to legacy, transition, and new business activities.
- Allocate realistic budgets to accomplish all this in a fast, effective manner.
Above all, financial services firms, and corporates need to maintain the sense of urgency and commitment that drove their LIBOR transition programs during 2021. And while there are only 18 months until June 2023, LIBOR-transition leaders are gearing up for strong client outreach activities as early as the first quarter of 2022. Organizations are strongly encouraged to use this precious time to properly complete a smooth transition to a post-LIBOR environment, make the changes required to position themselves for profitable growth, and make sure “things don’t get out of hand” in the face of continuing uncertainty and increasing competition.