Obviously, the whole practical business of replacing LIBOR for an estimated US$350trn of securities will bring a raft of work. Existing legal documentation will pile up on the desks of corporate lawyers and compliance departments as fall-back terms are investigated or inserted, replacement terms, trigger provisions and contract adjustments are sought and made to existing swaps and loans and new documentation is introduced, allowing a transfer away from LIBOR. Treasurers will have to monitor a range of new and very different interest rate benchmarks, look at their suitability for individual contracts, and examine yield curves, hedge accounting rules, balance sheet impacts.
A close watch will be kept on ISDA to ensure the timely incorporation of new forms and definitions when they eventually emerge. Quite rapidly, standard terms and conditions will be introduced covering these changes. Treasurers will find their budgets stretched as transaction costs and operational risks rise alarmingly in the short term, staff scramble to be trained appropriately, IT expenditure grows, and they themselves face significant time pressure. None of these, however, will be insuperable obstacles to their work, and treasurers may even enjoy their time in the corporate spotlight.
In fact, if this were the end of the issue, treasurers would not need to worry. Some extra work for the lawyers, sure, and some long nights in the office, but nothing fundamental once the switch is made. Unfortunately, that is not so. Much greater attention has been paid by regulators, as usual, to solving what they believe is the current problem, and virtually none to future problems that can emerge. With a plethora of future reference rates (RFRs) the possibilities for arbitrage between them is immense. Treasurers in Europe may also be concerned about using US Treasury overnight rates such as the BTFR, for example for sterling mortgages. New basis risks and accompanying arbitrage opportunities may emerge between contracts run on different RFRs, an entirely unintended consequence of the end of LIBOR.
The unsecured overnight rate, SONIA, used for sterling bilateral trading, as intended by the Bank of England working group, moreover seems no less open to potential manipulation than LIBOR before it, and the same applies to all the other RFRs for other currencies.
Even if there is never any manipulation of actual trades – even in profoundly illiquid markets at especially difficult times, and this is almost impossible to credit, given the history of market manipulation – the problem of interest rate squeezes will loom large. An example would be at the end of a quarter or financial year, when banks as a group report their financial results, or when economic conditions themselves are exceptionally volatile.
The effect would be rather as if all chocolate worldwide were suddenly to be priced, not on the strategic policies of large cocoa manufacturers, but on the cocoa futures market price right now. This potential volatility in rates, and its consequences, rather than the administration issue, is possibly the real future headache for corporate treasurers.