In July 2017, Andrew Bailey, Chief Executive of the Financial Conduct Authority (FCA), said that after the end of 2021 it will “no longer be necessary for the FCA to persuade, or compel, banks to submit to LIBOR.” And in another speech in 2018, Bailey emphasised that firms should treat the end of LIBOR “as something that will happen and which they must be prepared for.”
Replacing LIBOR will be a number of alternative reference rates or risk-free rates (RFRs) covering the five currencies in which LIBOR is calculated, namely CHF, EUR, GBP, JPY and USD. The new rates differ from LIBOR in a number of ways – for example, liquidity levels are currently far less than for LIBOR; credit risk is not built in; rates are backward-looking instead of forward-looking. And with different administrators covering each RFR, the new rates also differ from each other.
Ready or not?
Despite the FCA’s statements on the topic, not everyone believes that LIBOR’s demise is a done deal. In June 2019, an audience poll at the European Money Market Fund Forum found that 57% of delegates did not believe LIBOR will actually disappear.
But while some commentators have cast doubt on whether LIBOR’s end is truly nigh, it’s clear that treasurers need to assume this will be the case. Indeed, on 16th January the FCA and Bank of England announced that 2nd March 2020 had been identified as an “appropriate date” for market makers “to change the market convention for sterling interest rate swaps from LIBOR to SONIA (the Sterling Overnight Index Average).”
“This is a global issue that can affect corporates’ borrowing, working capital and commercial agreements – anything that includes interest rates or some formula for interest rates,” says David Stebbings, Director, Head of Treasury Advisory at PwC. “So there are all sorts of things that need to be assessed and changed, and that involves quite a lot of work.”
For starters, treasurers will need to have a clear view of which of their contracts include references to LIBOR – a task which may take considerable effort, depending on how such contracts are stored and how readily they can be searched.
François Masquelier, Founder of SimplyTREASURY and Chairman of ATEL (the Luxembourg Association of Corporate Treasurers), points out that references to LIBOR may be hidden in multiple contracts throughout a group. “There are tons of commercial and rental contracts, financial instruments, credit documentation, clauses (internal or external), funding agreements, where possibly such a reference rate could be hidden,” he says. “They will all have to be amended without exception.”
The scope of the project may extend further than treasurers initially expect. Stebbings notes there may be secondary effects, as changing interest rates on inter-company loans can have transfer pricing implications and modifications to agreements may affect accounting – “all potentially added challenge.” What can further complicate the effort, Stebbings points out, is that implications may extend well beyond treasury, particularly when supplier or customer agreements are involved.
For existing contracts, treasurers may in some cases find there is a need to renegotiate. And where new instruments are concerned, treasurers should make sure the paperwork reflects and accommodates the expected end of LIBOR.
Meanwhile, contracts are not the only area treasurers should be focusing on. “Beside the review of all loan documentations and contracts to track LIBOR references (to be amended), do not forget to contemplate IT systems to understand how lending and hedging activities will be treated,” Masquelier warns.
He also points out that the area of hedge accounting may bring some of the biggest unanswered questions. “If you read the international accounting standards literally, given LIBOR will not exist post-2022, it is arguable that hedges will be made ineffective,” Masquelier says.
But while the LIBOR challenge may be considerable, at this stage many treasurers have yet to get their teeth into this issue. Masquelier says there is concern among many businesses that they “simply don’t have the time or manpower to devote to determining their exposures, understanding the impacts, and then formulating and executing a plan for adaption.”
And Stebbings says that while bigger companies are carrying out analysis, many others have yet to tackle it – “in fact, it’s mainly financial institutions that are spending money on it at the moment.”