LIBOR is regarded as the “most important number in the world” and the most embedded fundamental in lending, trading and valuation activities. Financial services firms are at a challenging crossroad, where they are having to consider transitioning away from “the” number.
LIBOR has been plagued with controversies since as far back as 2003 where global banks were found guilty of manipulating rates for their own benefit. Post investigation, the FCA took responsibility to switch its supervision from the British Bankers Association to the ICE Benchmark Administration (IBA). However, the setting of LIBOR is still shrouded in conduct risk. As a result, the FCA has taken a lead together with global regulators to encourage market participants to transition away from LIBOR to alternate risk free rates ( RFRs).
Rocky Road Ahead?
The decision to transition away from LIBOR has presented financial services firms with an enormous challenge as central banks and regulators across the globe push their advocacy. The main challenges faced by the industry center around:
- A forward-looking-term structure for RFRs across the tenor landscape to facilitate timely valuations and settlement when needed
- Fall-back clause provisions within trading and lending agreements which could date back a decade
- Relative liquidity of forward-rate agreements based on the RFRs offered by exchanges
- The role of LIBOR after the soft 2021 deadline – “Synthetic LIBOR”
- How new issues and financial products referencing RFRs will need to be structured
These issues need real permanent industry solutions to encourage transition plans to gather early momentum to drive change. The International Swap Dealers Association (ISDA), global exchanges and regulators are an integral part of global working groups looking to address these issues. However, sufficient progress is yet to be made in order to address these complexities and to convincingly persuade market participants to transition away from LIBOR.
Our Expert View
Our experience suggests, financial services firms are choosing to address the transition internally, and in isolation, which has led to a growing lack of consensus amongst market players . This is primarily due to the transition being advocated by global regulators, rather than being a mandatory requirement with a definite deadline.
Based on the recent steer and commentary by global regulators, we feel firms should look to initially address the following challenges:
- Isolate and comprehend the impact of transitioning away LIBOR on their lending and trading activities both for themselves and their clients
- Quantify and manage the commercial impact of the transition
- Identify and manage the legal impact on contacts with clients and counterparties
- Adopt a credit-spread methodology for RFRs that addresses basis risk across the term structure reducing the impact on valuations, lending and trading activities
- Mobilize effective and internally collaborative LIBOR transition programs and plans to address internal change requirements in line with market consensus and regulatory working groups
Time to Think Beyond Band-Aid Solutions
Financial services firms should not assume that the temporary measures partially addressing the challenges are sufficient and will endure post 2021. “Synthetic LIBOR” and “Fall-back” clauses are temporary fixes for legacy contracts and valuations. Firms cannot rely on these for new business and transitioning away from LIBOR. They must collectively address the issue and derive market consensus without delay from a lending, trading, legal and operational perspective.
At Infosys consulting, we are working with our clients to understand the size and depth of this huge challenge. Our established business advisory and diagnostic capabilities are accelerating our client’s ability to address the transition across their business’ with confidence. How ready are you?
Contact us at email@example.com
Author: Manoj Lad, Co-Author: Bhav Patel, Practice Head Jayakumar Venkataraman
Senior Principal, Infosys Consulting
Manoj has over 20 years’ experience working in capital markets as a trader and structurer in credit and rate derivatives for top-tier global investment banks. He is a senior member of our banking and capital markets practice in the UK and leads many of go-to-market propositions and engagements governing front to back office solutions and regulator change capabilities. His experience leading large scale regulatory change engagements for investment banking and market infrastructure clients coupled with his strategy and advisory experience have enabled him to shape the financial services industry over the past decade.
Principal, Infosys Consulting
Bhav has 15 years’ experience in capital markets and management consulting and is part of our banking and capital markets team. He has worked across operations and middle office and extensive experience in developing target operating models for organizational change for various financial services clients. He has managed a diverse client portfolio of engagements ranging from regulatory change, full business and technology transformation to managed services. Bhav specializes in advising financial institutions in defining their future strategy and has a keen interest in automation within the sector.
Managing Partner, Financial Services & Insurance Practice, IC Europe
Jayakumar has more than 23 years of experience in the banking and financial services industry. He leads our Financial Services & Insurance practice in Europe. He has been with Infosys for over 15 years, all of it in consulting under various guises – DCG, IC, MCS and Lodestone. Prior to joining Infosys, Jayakumar worked as a corporate banker at Citibank, American Express and BNP Paribas in the areas of transaction banking operations, credit risk management and corporate relationship management.