Regulators are putting more pressure on banks to speed up their transition away from the London interbank offered rate (Libor). Corporate treasury professionals with Libor exposures should take note, because this regulatory push could mean that their banking partners could move away from the controversial benchmark rate ahead of schedule.
Last week, regulators urged banks to eschew contracts that reference Libor, as well as devise plans for contracts that expire after 2021 Libor transition date. Banks currently hold approximately $170 trillion in swap contracts based on Libor, and about a third of them mature after 2021, U.K. Financial Conduct Authority (FCA) Chief Executive Officer Andrew Bailey in a speech last week.
Bailey stressed that banks that the FCA and the Prudential Regulation Authority supervise will need to demonstrate that that they have plans in place to reduce dependencies on Libor. “The pace of that transition is not yet fast enough,” he said.
The FCA isn’t alone. Representatives from the U.S. Commodity Futures Trading Commission (CFTC), the Federal Reserve and the Financial Stability Board also reaffirmed the need for banks to migrate away from Libor last week.
Jennifer Earyes, director, treasury risk for Navient, stressed that it is more important than ever for treasury departments to take an inventory of their exposure to Libor. “Don’t ignore this and assume that it will get results on its own,” she said. “Prepare fallback provisions in anything you do going forward.”
On that note, Earyes believes that treasurers should begin to explore the Secured Overnight Financing Rate (SOFR), an overnight rate based on a Treasury repo transactions and the preferred alternative rate for USD Libor. “Become more familiar with it, and speak with your bankers to see when it would be appropriate to use the different products that they would normally use Libor on,” she said.
The International Swaps and Derivatives Association (ISDA) has also gotten in on the action, launching a market-wide consultation on issues related to new benchmark fallback rates for derivatives contracts that reference certain interbank offered rates (IBORs). The fallbacks, which will be risk-free rates (RFRs), will be included in the ISDA definitions for interest rate derivatives and will apply to new IBOR trades. ISDA also plans to publish a protocol that would allow participants to include the fallbacks within legacy IBOR contracts.
“Having robust fallbacks for derivatives contracts that reference an IBOR is critical for the stability of the financial system,” said ISDA’s Chief Executive Scott O’Malia. “If an IBOR permanently ceases to exist, it is vital that market participants have certainty that their existing IBOR contracts will fall back to a robust and clearly defined reference rate. But it’s also important that the switch to the fallback rate occurs with the minimum amount of disruption, which is why an adjustment to the RFR is necessary.”
The ISDA consultation covers GBP Libor, CHF Libor, JPY Libor, TIBOR, Euroyen TIBOR and BBSW. ISDA has plans to launch supplemental consultations covering USD Libor, EUR Libor and EURIBOR, but is requesting preliminary feedback on the technical issues associated with fallbacks for these benchmarks.
“While it’s important for corporate treasurers to look into this consultation, it’s extremely technical,” Earyes said. “Those rates are not predominately used by corporate treasurers, but if they do use them, it’s something to take a look at.”
For more insights, be sure to visit AFP's Libor Transition Guide here.