This issue’s question

We shouldn’t be thinking ‘if’ but ‘when’, which will be by the end of 2021. The worst approach is to hope that this all goes away, because it won’t. It’s also worth remembering all the problems with LIBOR: that it is no longer based on a substantial number of transactions, that it includes a bank credit spread, that it was famously manipulated for many years. Moving to a robust, transaction-based, virtually risk-free overnight rate will eventually be a massive improvement. The practical issue is getting there.

The first challenge is close to home with debt (bonds or loans), interest rate derivatives and related treasury issues such as intra-group funding and hedge accounting. This is where all the attention has been, because that is where the banks and regulators have been involved. For the short term, we can’t do much more in this area than watch and wait to see what comes of the work ISDA is doing on fallbacks, the debate on possible risk free rates (RFR)-linked term rates, and the papers trade associations are producing on creating standard contract terms and market conventions.

It is important to ‘future-proof’ any new debt issuance or loan facility with provisions to change benchmarks when necessary. Unfortunately, there’s going to be an (expensive) IT project to change the TMS and other systems but we can’t start that yet without being confident exactly how to change them.

There’s no shortage of seminars, roundtables and webinars to attend on the subject. I saw a chart at one recently which showed that 80% of the total exposure to LIBOR (by value) was in derivatives, and 20% in the ‘cash market’ meaning bonds and syndicated loans. The problem with this statistic is it’s like saying 80% of people support Manchester City and 20% Brighton and Hove Albion – there’s the rest of the Premier League (LIBOR exposure) to think about, and this is where we need to be starting work now.

A few examples, starting in treasury and moving outwards into the outer reaches of corporate life: LIBOR appears in project finance agreements, supplier and receivables financing deals, transfer pricing documentation, tax rulings, investment management performance fees, pensions and treasury benchmarking, ship and aircraft leases, real estate rents, late payment clauses, government infrastructure subsidy arrangements, working capital adjustment clauses in supply contracts, lock-box agreements in M&A deals…and many more!

So there is a massive practical issue here, but it’s more than just one for the treasurer: it’s going to need help from legal, procurement, IT, tax, accounting, commercial finance and pretty much everyone else in the organisation who ever looks at a contract. Renegotiating contracts is an unpopular enterprise and the challenge is to restrict any discussion to LIBOR only. This is another area where we can hope for help from the LIBOR working groups on recommended contract language, but in the meantime, we can start campaigning for budget and time from the right people.

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.

The cessation of LIBOR and other interbank offer rates (IBOR) presents a significant practical challenge for corporate treasurers. IBORs are a key bedrock of the financial system, and are found in many treasury products such as loans, bonds and swaps. IBORs have also permeated outside treasury products and into the broader business environment, as they are used in accounting, commercial contracts and a variety of other contexts. Set out below are three key challenges which will confront corporate treasurers as the world moves beyond IBORs.

The first challenge is that the replacement “risk-free” rates which will replace IBORs are not the same as IBORs. They are overnight as opposed to term rates, and so do not factor in counterparty credit or term interest rates. This difference will have an economic impact, as the new rates are likely to present a different set of interest rate expectations to the old IBORs. The transition to the new rates will provide challenges for treasurers as they come to terms with the new rates and the economic impact they present.

The second challenge is that, at present, different jurisdictions and different treasury products are pursuing different solutions to the new replacement rates. As an example, the swaps market favours an alternative rate which is not suitable for loans, leading to the possibility of a split between a loan and hedge which should be intrinsically linked. Similarly, there is a marked split between the USA, UK and Europe in how the new risk-free rates should be calculated, creating a geographical fragmentation by currency and jurisdictions for products which should operate the same way. Navigating these differences, whilst trying to ensure consistency across the business, will be a significant challenge for treasurers.

The final challenge is timing. Regulators across the globe, including in the UK, have consistently stated 2021 as the date by which IBORs must stop being used, and new alternative rates be used in their place. That is little more than 18 months away, and much work remains for treasurers in assessing the business exposure to IBORs, understanding the new replacement risk-free rates and managing the transition away from IBORs.

In many cases there is little advanced preparation which can be done, as the new replacement rates are not yet available and/or in sufficient liquidity to allow a corporate to begin accessing them. The main banks are also busy in conducting their own transition plans, and in many cases have not yet begun dialogue with their clients to commence the transition.

Unless the regulatory timetable is relaxed, and the targeted date of 2021 for IBORs to cease is pushed back, it seems likely that a significant amount of work will need to be done in a very compressed timeframe to ensure corporates are adequately prepared for the cessation of IBORs.