Transitioning from Libor to a new benchmark rate will be extremely painful but ultimately beneficial for treasurers, argued panellists at the UK’s annual Association of Corporate Treasurers (ACT) conference.
“It is very important that we realise that [Libor] is going stop, but once we have got through the serious pain of transition, we will be in a better place,” said Frances Hinden, vice president of treasury operations at Shell International.
The London Interbank Offered Rate (Libor) is an important benchmark rate that underpins an estimated $370tn of financial products around the world, including some mortgages, pensions, consumer loans and bonds.
However, British banks will not be required to sustain the London Interbank Offered Rate after 2021.
Tom Gilliam, corporate finance director, GlaxoSmithKline (GSK), said: “We have to assume [Libor] will cease at the end of 2021. There might be some sort of alternative rate published which at best will be a non-robust benchmark, but that is not something that I would want to rely on.”
“There might be some sort of alternative rate published which at best will be a non-robust benchmark, but that is not something that I would want to rely on”
Hinden agreed: “The end of 2021 isn’t very far away. We’re all caught up in planning for March 2019 or just putting Europe’s Markets in Financial Instruments Directive (MiFID II) into place, but we must start working on this now.”
Libor’s eventual demise was triggered shortly after the financial crisis of 2008 when several banks were found to be committing significant fraud by manipulating the rate submissions.
In an audience poll at the ACT conference in Liverpool, 16% of people said they didn’t think a transition away from Libor would impact them.
“I don’t believe there is any corporate treasury in this country to whom it doesn’t apply,” Hinden contested.
“I don’t believe there is any corporate treasury in this country to whom it doesn’t apply”
To give an idea of the extent of Libor’s impact, Hinden said: “All of my intragroup funding is Libor-based. All of my current accounts, internal and external, charge interest based on Libor.
“I was at pension fund committee meeting last week, and our investment managers discount based on Libor. A lot of pensions discount based on the Libor curve. A lot of default rates and contracts are Libor based,” she said.
“If you had to do a word hunt across any treasury related-document, most of you won’t be surprised how often that comes up, but anyone who thinks it’s not relevant will be.
“Derivative swaps or floating rate debt is only the tip of the iceberg,” Hinden added.
Despite this, it seems that many are yet to address life without Libor.
On this issue, Gilliam said: “It is happening; you can’t just put your fingers in your ears and hope it goes away.”
Hinden said: “We have existing cross-currency swaps out past 2021. What shall we do with them? What will the consequences be for our hedge accounting? I don’t know.
“I spoke to an accountant [about this issue] at the conference yesterday and they just agreed it was going to be a problem,” she said.
Sonia takes the lead
The Bank of England (BoE) has backed Sonia (the Sterling Overnight Index Average) as its preferred risk-free reference rate (RFR) which has been established for about twenty years.
Hinden is the co-vice chair of a working group dedicated to sterling risk-free reference rates, initiated by the BoE, which has been mandated to facilitate a transition to the proposed Sonia benchmark, across the sterling bond, loan and derivative markets.
Libor has five different currency benchmarks, so choosing a new benchmark is an international initiative, not just a UK one.
“What worries me more than US dollar is the Eurozone. They are a little behind everyone else. The challenge of coordinating 27 countries will slow them down further too”
Sarah John, head of sterling markets division at the BoE, said: “The working group is looking at what sensible international model for coordination there might be.
“We need a way to tackle these issues. But it can’t be done in the UK on its own – we need to coordinate with authorities. It’s on our radar and please do keep engaging on it with us,” she added.
While, Hinden’s company, Shell, is only involved in the Sterling working group, she told the ACT audience: “I know the dollar Libor problem is huge and drowns the GBP Libor issue”.
“What worries me more than US dollar is the Eurozone. They are a little behind everyone else. The challenge of coordinating 27 countries will slow them down further too,” she added.
Is Sonia on your contracts?
One key issue for treasurers is legacy conversion, according to John.
Gilliam said: “If you have any long-term swaps that go on beyond 2021, then, if you don’t already have fall-back language written in those contracts, you are at risk as to what will happen in the future.
“I think it is wise for any company to take a look at those contracts and see if they can be restructured to reference Sonia rather than Libor. This is something we have been looking at in GSK because we don’t want to step into the unknown in 2021,” he advised.
John encouraged treasurers to think about how to adapt their business model now to use risk-free rates rather than Libor.
“The longer you use Libor, the bigger the problem gets as the legacy issue grows”
“The longer you use Libor, the bigger the problem gets as the legacy issue grows. Think about how you can reduce that legacy now. Think about how you can use an over-night risk-free rate,” she said.
When the industry starts to see documentation based on overnight rates it will be a “game changer”, John argued.
“Then we can start to get templates out there on how overnight rates can be written into contracts,” she said.
Gilliam added: “Look into any contracts your company enters into that would reference Libor; you need to either enter into contracts that reference Sonia or have contracts that recognise what happens Libor goes away.
“It’s important to make sure you have those conversations,” he added.
Relying on fall-backs?
Huge swaths of financial documents, including those mentioned by Hinden, reference Libor but with no serious alternative benchmark. If these contracts are not updated before Libor ends in 2021, many treasuries will be required to use the Libor fall-back rate.
“A fall-back is supposed to be what happens if a rate isn’t published for a day or so,” explained Hinden.
“There are a lot of contracts saying that if the rate isn’t published, use the fall-back rate. That’s fine if there’s a market disruption, Bloomberg goes down for a day or the Bank of England have an away day. You can look at yesterdays.
“If the rate stops being published, you effectively have a fixed rate as you will be stuck on the rate of the last day forever,” she said.
One treasurer noted in the panel debate noted that there is plenty of research material from the banks on Sonia but on the sales side of the same banks, they are trying to sell treasuries a floating rate note, or fixed rate note in relation to Libor, rather than Sonia.
After enquiring, the treasurer claimed that the banks said no one is interested in Sonia rates.
“We seem to be stuck in this feedback loop where the corporates are saying no one is helping us and the banks are saying no one is asking for it”
“We seem to be stuck in this feedback loop where the corporates are saying no one is helping us and the banks are saying no one is asking for it,” said the panellist.
Mark Luscombe, SEB Bank’s UK country head, told The Global Treasurer: “It’s fair to say that there’s that issues have been identified and solutions addressing those issues aren’t there yet.
“From what we’re hearing from clients, they need the ability to forecast what their interest expenses are going to be and the solutions that are on the table don’t really give them that ability in the same way that the Libor rate does.
“That that’s an issue for treasurers,” he continued.
He added: “They get the rate after the fact. When you’re running a treasury, trying to forecast cash flows and you want to hedge exposure, that is a bit of an issue.”
Hinden is confident that the industry will be better off once it has transitioned to a new benchmark.
When Luscombe was asked whether he agreed, he replied: “It’s difficult to say. The discussion is at a fairly early stage.”
He pointed out that while the ACT has a working group looking at this issue, other industry sectors such as loans and law, do not.
“I’m sure we’ll end up with something that’s going to work. There is no doubt. But before we get to that point, I don’t have a good basis for saying what the process for getting there is or what the future is going to be,” he concluded.