OK, it may not be truly apocalyptic but the financial industry is heading towards a seismic shift with the anticipated end of interbank offered rates (IBORs). IBORs are average rates at which certain banks could borrow in the interbank market and range in tenors from overnight to 12 months. These rates are referenced through a wide range of products including derivatives, bonds, loans, securitizations and deposits, which are used by a broad range of market participants from sophisticated investment banks to the regular home-owner.
Due to the LIBOR scandal - where a number of financial institutions were found to be fixing rates via fraudulent submissions - and the virtual overnight evaporation of the unsecured bank funding market as a result of the financial crisis in 2008, benchmark reform initiatives have recommended reducing reliance on IBORs. With the viability and sustainability of these reference rates in doubt, the FCA declared in 2017 that they would no longer require panel banks to make LIBOR submissions after 2021 and the European Central Bank has stated that they want a “risk free” alternative in place by 2020. While this doesn’t mark the absolute end of the IBOR family, market players must consider the risks associated with market-wide transition on the horizon to alternative risk-free rates (RFRs).
A recent survey, identified that from the 150 banks end users, infrastructures and law firms who responded across 24 countries, awareness of the benchmark reform was high, however, actions to mitigate the risk or prepare for the transition were minimal to date.
To avoid a post-apocalyptic financial environment come 2022, market participants must work to understand their scale of exposure to IBORs and formulate strategies to reduce it. Firm-wide programs should be established to mobilise the following activities:
As already acknowledged the current dependence on IBORs by all sectors of the financial markets is vast. Looking at step one and considering a typical investment bank, where arguably the impact will be greatest, a thorough impact assessment should begin by collating an inventory of use cases across front, middle and back office:
Firms should consider not only the financial exposures within these functions but also the impacts to technology (e.g. systems, market data sources, calculations etc.) and control frameworks (e.g. limits, tolerances etc.).
Once the firm has a detailed understanding of its exposure to the IBORs it can start to formulate a transitional plan, considering adjustments to product approval processes, trader mandates, model formulae and the active trading of existing positions to name but a few components. In addition, transitional programs should consider impacted clients, developing a suitable client communications strategy both internally and externally.
A post-IBOR future may look daunting, however if companies invest now to thoroughly understand the risks they face then they can establish transitional programs which can flex and adapt as the markets response becomes clearer.
If you have any queries please contact Bruce Laing, Partner: firstname.lastname@example.org