June 26, 2018 - On June 25th, ISDA, AFME, ICMA, SIFMA and SIFMA AMG released the eagerly awaited (by us, at least), “IBOR Global Benchmark Transition Report”. While the 54-page tome might seem daunting, we would direct time-limited readers to pages 8-9 for the executive summary and pages 35-36 for an IBOR Transition Practical Checklist. For the particularly time-constrained, we offer a recap below. But first, we flag a few helpful definitions: IBORs simply are the “Interbank Offered Rates”, such as LIBOR, TIBOR, EURIBOR, etc. Risk Free Rates – or RFRs – are just the proposed LIBOR replacements, such as SOFR or SONIA. The RFR Working Groups are the official sector led groups, such as the ARRC in the U.S.
And now, the survey results! First, respondents are aware of IBOR transition plans and are gearing up: 87% of respondents are concerned about IBOR exposures and 76% have begun internal conversations about transition to new RFRs. However, far fewer have taken tangible steps: Just 11% have allocated budget and just 12% have developed a preliminary project plan.
Why would folks hold back? First, there is limited knowledge. Respondents had a qualified acceptance or understanding of IBOR vulnerabilities and the lack of fallbacks. Some did not know their IBOR exposures (or how they would reduce over time). In addition, many of the products necessary for the adoption of alternative RFRs do not yet exist. Respondents also were concerned about basis risk – the risk that different products will not move in line with each other – particularly if different products or geographies transitioned at different times. Finally, respondents simply didn’t have a clear sense of direction.
Despite this uncertainty, certain key elements of successful transition emerged. First, a long runway for transition is needed. Second, market participants need to create new RFR products and create deep and liquid markets in them. Third, forward-looking term reference rates were necessary (at least for cash products). Fourth, tax and accounting rules needed to align with transition plans.
So that is all very challenging. But what should market participants do to effectively plan for a successful IBOR transition? The report asks readers to consider five helpful questions.
Question One: Have you mobilized a formal IBOR transition program? To do this, a firm would: 1) Appoint a senior executive to own and manage the transition. 2) Establish a robust program governance structure to oversee the transition to new RFRs. 3) Allocate budget and staffing to execute implementation. 4) Establish program workstreams with clear objectives, milestones and work products. 5) Initiate internal stakeholder outreach and education.
Question Two: Have you assessed your exposure to IBORs? To do that, a firm would: 1) Develop an inventory of financial instruments linked to the IBORs. 2) Quantify the IBOR exposures across business lines and products. 3) Calculate financial exposure expected to roll off prior to year-end 2019, 2020 and 2021. 4) Evaluate operational exposure to the IBORs. 5) Implement reporting to monitor exposure to the IBORs.
Question Three: How would a permanent cessation of IBORs impact you and your clients? To determine this, a firm would: 1) Review existing contracts and assess fallbacks (see this note for loan insights). 2) Determine where “repapering” is needed and contact clients as appropriate. 3) Collaborate with market participants and industry working groups to enhance fallback provisions (which will be discussed at the ARRC July 19th Roundtable). 4) Mobilize efforts to implement required contract amendments (and talk to your trade association!).
Question Four: What is your external communication strategy? To execute this, a firm would: 1) Define a communication strategy to educate clients. 2) Identify other external dependencies. 3) Develop an advocacy plan to share views with regulators, RFR working groups and trade associations.
Question Five: Have you defined a transition route map? To do this, a firm would: 1) Review publications from the Official Sector Steering Group (OSSG), the RFR Working Groups, the IBOR Transition Roadmap and trade associations (among others). 2) Apply to participate in relevant RFR Working Groups. 3) Contribute to the demand for, design of, and trading in new products that reference alternative RFRs. 4) Determine required infrastructure and process changes to support transition to alternative RFRs. 5) Develop an implementation route map with key projects, milestones and ownership.
While that all might appear daunting, LIBOR transition should not be ignored. The reality is that there is a lot to do and not an excessive amount of time to do it. However, with the right plan, it is doable.