The clock is ticking toward a major shift in finance: the end of the London Interbank Offered Rate (LIBOR). It’s the benchmark for US$350 trillion in financial contracts worldwide, and it will give way to new reference rates in 2021. To prepare, firms may need to update front- and back-office systems quickly. For many, delays could mean disruption to operations and hits to profits. Leading firms can reshape the market landscape through internal streamlining, product innovation and client outreach.
Alternatives to LIBOR are emerging. In the US. For example, firms already have issued more than US$46 billion in floating rate debt tied to the Secured Overnight Financing Rate (SOFR). SOFR is still in its infancy, but it appears to be gaining acceptance at an exponential rate, as measured by daily trading in SOFR-linked futures and volume of SOFR-linked debt.
The London Interbank Offered Rate (LIBOR) serves as the benchmark for an estimated US$350 trillion in financial transactions worldwide. The switch from LIBOR to alternative rates is more far-reaching than other major changes in finance, including Sarbanes-Oxley and MiFID II. Many financial institutions could need to quickly update dozens or even hundreds of front- and back-office systems. They’ll want to reduce product, legal, market, credit and operational risk by revamping the full range of business functions—from strategy and financial management to accounting and contract management.
First movers are quickly gaining expertise with the new benchmarks. While making the transition they are seeking an edge by creating new products, streamlining operations and improving customer relations. Firms without a credible conversion plan could risk a hit to profits, disruption to their full range of operations and competitive decline.
LIBOR is giving way to five alternative rates that differ by region, currency, tenor and basis. But LIBOR differs significantly from the alternative rates, making the transition especially complicated. For example, LIBOR is a forward-looking term rate with a range of seven maturities up to a year, while the alternatives are backward-looking overnight rates. Most financial firms need to switch to the new rates across the full range of products, coordinating with customers and vendors. Regulators aren’t guiding the transition but collaborating with the industry to plot a way forward. So firms, to an extent, must create their own roadmaps for transition.
Financial institutions should consider taking several steps that will be needed regardless of the contours of post-LIBOR finance. These include creating a governance structure to execute, manage and monitor the transition, identifying contracts that reference LIBOR and educating employees and clients. Over time, many companies will want to fine-tune their LIBOR strategy. For example, they should track changes in taxation and accounting rules and monitor the evolution of fallback language to reduce litigation and reputation risk. Leading firms will capitalize on the transition’s sweeping changes by making internal improvements in agility, collaboration and decision making. They will be in a position to set the terms for post-LIBOR finance.
Adam Gilbert, Global Head of FS Regulation at PwC, explains why it's critical that companies prepare now for the transition from LIBOR to new reference rates.
Karyn Daud and Nassim Daneshzadeh discuss the replacement rates for LIBOR, and why they are being used.
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Financial Services Advisory Regulatory Leader, PwC US
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Financial Services, Principal, PwC US
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