BankingRegulators nudge market on Libor transition

Regulators nudge market on Libor transition

Banks should acclimatise themselves to new rates ahead of Dec 2021 deadline

A joint statement issued by the United State’s leading financial regulators has stressed the need for market participants to make progress on Libor transition plans with haste.

“Given consumer protection, litigation, and reputation risks, the agencies believe entering into new contracts that use USD Libor as a reference rate after December 31, 2021, would create safety and soundness risks and will examine bank practices accordingly. Therefore, the agencies encourage banks to cease entering into new contracts that use USD Libor as a reference rate as soon as practicable and in any event by December 31, 2021.”

The statement was issued by the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency.

With Libor set to be phased out at the end of next year, the big challenge for banks and corporates is to adopt the new risk-free rates (RFR).

“Starting to build expertise up on this is really important,” said Doug Laurie, Libor transition lead at Barclays, during this year’s BAFT conference  “By doing that and starting to use the new rates, even if there is a convergence over time, this will build confidence for yourself, for your institution, but also in the market as a whole.”

Matthew Ayearst, a Libor consultant, said that most banks and corporates need to develop a workplan given how many functions the transition away from Libor will affect.

“You have to come up with a project plan and leverage it to create the appropriate work streams in all the impacted areas. Areas like technology, and operations; treasury because they will have to change FTP, balance sheet management, front office risks, legal and set up a governance structure.”

With the new RFRs based on different asset classes, Ayearst said there could be increased levels of volatility initially.

“The fact is that these new risk-free rates are based on different asset classes. Some of them are based on the repo market and the repo market is not exactly the same as the interbank market that Libor is based on.”

He gave an example earlier in March, where the pandemic caused a spike in Libor interest rates but there was little movement in Sofr – the rate being introduced in the US. However, panelists agreed that once Libor is phased out, eventually there would be convergence among the RFRs.

“At some point, the market will converge into one rate, everyone will have a consensus what will be used. That is the hope,” said Asyera Theng, vice-president at MUFG Bank. “At the same time, we need to be prepared and we can’t wait for things to happen.

“We have to be vigilant and prepared, what’s impacted and what needs to be updated from the bank side in order to adapt to the new rate quickly.”

Panelists agreed that it was better to begin making the transition now, than to abruptly change come December 2021.

“[From a bank’s perspective], front running this on an education and information perspective with your clients is the approach to take,” said Ayearst. “If you can partner with a client and start looking at what a test trade would look like, then the client is not going to be surprised. You can also test the plumbing; both systems and processes on both sides.”

That echoed the regulators’ sentiment.

“The Libor transition is a significant event that poses complex challenges for banks and the financial system.  The agencies encourage banks to cease entering into new contracts that use USD Libor as a reference rate as soon as practicable and in any event by December 31, 2021, in order to facilitate an orderly—and safe and sound— Libor transition.”

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