The London Inter-bank Offered Rate or LIBOR has been a popular interest-rate average calculator used by financial institutions across the world. But with LIBOR being phased out, financial institutions need to have a clear strategy in place to embrace a world with a different reference rate.
But LIBOR transition brings with it several challenges that need to be dealt with caution. Learn about the top things financial institutions need to consider while transitioning from LIBOR and successfully circumvent the many challenges.
As an average interbank interest rate, LIBOR has enabled financial institutions to use a standard rate for lending purposes. Offered in over 7 maturities – from overnight to 12 months – and in 5 different currencies, LIBOR is adopted both by institutions and private individuals as a benchmark rate.
Today, financial contracts worth $350 trillion reference LIBOR globally.
With its widespread adoption that started in the 1970s, LIBOR has been an industry benchmark for decades. But with interest rate manipulations becoming a common phenomenon, along with lack of liquidity and poor alignment with current market trends, LIBOR has become extremely vulnerable.
For these reasons, LIBOR is expected to be discontinued on December 31, 2021. This means banks, agencies, product companies, clearinghouses, market data providers, regulators, and insurance companies need to build a robust transition plan to move away from LIBOR to an alternative reference rate such as SOFR (USD), SONIA(GBP), ESTER(EUR), TONAR(JPY), or SARON(CHF).
Since the rate is referenced globally, the transition could affect organizations of all types and sizes through direct or indirect exposure. And, although the impact of the LIBOR transition on the Indian market is not clearly quantified, regulators have begun discussion on how best to deal with this major transformation.
The LIBOR countdown has begun, and banks and financial institutions worldwide have drawn up their plans to consider the implications and prepare for the transition to alternative benchmarks.
For a successful transition, organizations need to have basic groundwork and know about the steps involved in phasing out LIBOR that all streams of a financial institution, such as Legal, Operations, Finance, Technology, and Business, would need to undertake.
But there are several challenges that financial institutions need to be prepared for while embarking on the transition from LIBOR:
As a leading benchmark interest rate that has been adopted by financial institutions for decades, LIBOR has long served as the basis for interest rate calculation on various debt instruments. But with the benchmark vulnerable to undue modifications, it is on its way out. Moving from LIBOR to another alternative has to be done on an urgent basis, but even a single glitch or error during the transition could lead to credit market confusion and a wave of financial lawsuits.
Successful transition to alternative rates requires careful planning and close collaboration with a qualified outsourcing and consulting firm with deep domain knowledge and technology expertise. Since LIBOR transition has its impact lines flow across legal, financial, business, regulatory, technology, and the business in general, a partner can help in:
The pressure to transition from LIBOR to an alternative interest rate benchmark is intense, but the risks around a poorly planned transition are also too many.
For a successful transition, organizations must properly deal with challenges around legal, admin, validations, trade operations, and infrastructure. Engaging with a qualified partner is a great way to understand the many risks, prepare for remediation measures, and smoothly chart out the LIBOR exit.