This article was co-authored by Mayank Gupta
LIBOR (London Inter-Bank Offer Rate) was once regarded as the ‘most important number in the world’. In July 2017, the financial conduct authority (FCA) in the UK announced that banks will no longer be required to submit LIBOR rates after 2021. This has led to one of the largest benchmark reforms globally to transition from LIBOR-based rates to alternate reference rates and amend existing open positions.
In this blog, we will discuss the background and the present state of LIBOR-transitions, how COVID-19 has affected this landscape, and how Infosys Consulting can help financial firms navigate this uncharted territory in a timely and effective manner.
Alternates to LIBOR
Regulators and markets across the world are working together on their approach to the transition and to identify the alternate rates in their respective jurisdictions. In the U.S., the federal reserve board formed the alternative reference rates committee in 2014, to identify the replacement rate for LIBOR. After evaluating multiple alternate rates, the committee selected Secured Overnight Financing Rate (SOFR), a secure, wholly transaction-based overnight rate, as the alternate for LIBOR
LIBOR vs. SOFR
While LIBOR rates provide a forward-looking estimate, SOFR is a transaction-based backward-looking overnight rate, lacking term rates or a yield-curve. To overcome this challenge, the Federal Reserve Bank of New York started publishing 30, 60, and 90-day averages and a daily SOFR-index, together with the treasury department’s office of financial research. CME clearing plans to switch the discounting index to SOFR on the 16th of October.
LIBOR challenges post-COVID-19
COVID-19 has largely harmed LIBOR transition efforts for all firms from a priority focus perspective. In May 2020, the U.S. fed accepted industry demands and decided to issue emergency loans under the main street lending program benchmarked to LIBOR instead of SOFR, as proposed initially. Similarly, the regulators in the UK have extended the deadline to stop issuing LIBOR based loans by 6 months.
Despite near-term setbacks, regulators have reaffirmed that the overall timeline for LIBOR transition will remain unchanged, even if specific interim timelines are adjusted.
Firms must continue to drive their LIBOR transition programs and the review, planning, and development activities for modifying their technology landscape and operating models.
LIBOR transition poses complex challenges across sales and engagement through the contract lifecycle. These are:
- Adoption of replacement rate-contract management
- Accounting impact
- Risk management
- Operational risk
- Basis risk
- Model risk
- Conduct risk
- Hedging risk
Firms should address the challenges and imperatives in the following areas, some of which require organizational alignment:
- Establish an effective Transition Management Office (TMO)
- Define the interim and strategic operating model
- Client engagement
- Contract digitization
- Track exposure and impact due to LIBOR
- Enhance and update core systems and processes
- Risk management and finance
These challenges can be managed effectively, with the help of design-thinking based analysis and digitization through our in-house, AI-based platform.
Navigating the LIBOR-transition journey with Infosys Consulting
Infosys Consulting has been working with multiple firms on their LIBOR replacement journeys. Our competency helps drive program management and change management which are core requirements for the TMO. We help clients with process consulting, systems integration, data migration and testing. This includes ‘strength in regression’ testing which checks how the product-flow alters and aligns with the rate changes, ongoing support, and maintenance. Infosys teams create tools and templates to capture and document various aspects such as system, application and data flow, product front-to-back flow capture, business case templates all of which are done in a way that aligns with the firm’s strategic direction with industry standards (such as an Agile approach).
Design thinking (DT) based analysis can help provide an accurate assessment of a firm’s current state and define the interim and strategic future states.
We work with business and technology stakeholders to review the application landscape taking into account the firm’s transition strategy. This helps map product journeys with affected stakeholders or prioritize initiatives with the help of criteria that evolve during multiple sessions.
Our in-house platform NIA, an AI-based contract analysis tool, is useful for the digitization of contracts, abstraction of critical information, and generation of automated alerts.
It is particularly useful for renewals through contract redlining and tracking compliance or revenue leakage.
LIBOR transition presents a strategic opportunity for firms to enhance their operational efficiency and increase digital adoption across the business. While most large firms are taking steps to prepare for the transition, many continue to wait on the sidelines, hoping for a delay. Since there have been no such indications from the regulators, these firms must act now to meet the transition deadlines and prepare their systems and processes accordingly.
Principal Consultant, Infosys Consulting
Teenie Walia is a Principal Consultant in our financial services advisory practice. With over 18 years of cross-functional and global expertise, Teenie has developed a keen ability to manage and represent stakeholder interests She has worked across multiple domains and technology groups and is particularly interested in business functionality and its impact on process/ data flows. She is based out of our New York office and can be reached at firstname.lastname@example.org
Principal Consultant, Infosys Consulting