Time for banks and corporates to act on benchmark reform
14 Jun 18
The transition from Libor to an alternative reference rate will bring a hefty workload for corporate treasurers. Moreover, awareness of the task ahead is low
Treasurers, corporates and banks have all felt the effects of successive rounds of regulation since the financial crisis, and many of those measures have had far-reaching impacts. However, the transition towards an alternative benchmark rate in light of the FCA withdrawal of support for Libor from 2021 is a move with practicalities many have yet to recognise or plan for.
As Sarah John, head of the sterling markets division at the Bank of England, explained to the audience at the ACT Annual Conference, the transaction volumes underpinning Libor have dwindled significantly in the decade since the financial crisis.
As the conference audience heard, the message that Libor will cease to be operable as a benchmark rate appears to be reaching market participants only to a limited extent. Frances Hinden, vice president, treasury operations at Shell and a member of the Risk Free Rate Working Group, said soundings from market participants and corporates strongly suggest few are addressing the implications or facing the realities.
Some express a preference for Libor’s continuation. Other discussions centre on a ‘synthetic Libor’. However, the move to an alternative benchmark will ultimately provide a more solid base for contracts, longer term.
“It’s very important we realise [Libor use] is going to stop, and to realise that once we have got through the serious pain of transition, we are actually going to be in a better place,” she told delegates. “Three-month Libor is not actually a very good benchmark on which to base our funding.”
For banks on the Libor panel, there is an obligation to continue providing data to the market up until 2021, as Tom Gilliam, corporate finance director at GSK, pointed out. An immediate problem will be those contracts – whether for derivatives, swaps or other loan instruments – that straddle the 2021 cut-off point and which reference Libor.
The work to assess whether and how these might be adjusted to reference the sterling overnight index average (SONIA) – or whether such contracts will need to be repapered – will have to be addressed.
The potential workload for corporate treasurers and lawyers is difficult to assess, but shouldn’t be underestimated, as Hinden warned. The Risk Free Rate Working Group began its own impact assessment work looking at derivative markets, interest rate swaps and directly achieved floating-rate debt. This is just the tip of the iceberg, however, she said.
Other activities and products where Libor might be referenced include current accounts, investment-return benchmarks relating to company pension schemes and default rates in contracts.
Some of these issues may prove less complex to resolve than others. The International Swaps and Derivatives Association is working on fallbacks for derivatives contracts, for instance, such as overnight rates plus a spread. But these should only be seen as a backstop in the absence of a more permanent solution.
“It’s not going to be a satisfactory alternative to a proper risk-free rate in your contracts,” Hinden said.
While corporates need to address the extent of the issue within their own organisations, banks, too, need to look at offering alternatives. Anecdotally, there appear to be few instances where banks are promoting products that base off SONIA, for instance.
John confirmed that the Risk Free Rate Working Group is engaging on how bond and loan facilities based on overnight rates can be referenced, which suggests that treasurers will start to see templates that can potentially be built into contracts.
With awareness building and legacy contract issues to address, the benchmark rates question will remain very much at the fore for treasurers in the short term.