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At the annual conference of the Association of Corporate Treasurers, finance and regulatory experts turned their attention to the end of LIBOR and what it means for business.
Last updated: 26 Oct 2020 5 min read
The regulatory challenges facing corporate finance teams as the LIBOR system comes to an end was one of the key topics under discussion at the recent annual conference of the Association of Corporate Treasurers (ACT).
Sarah Boyce, ACT’s associate director, policy and technical, chaired a virtual session entitled An Update On The Transition From LIBOR, looking at the latest progress, regulatory developments and the steps businesses may to need to take ahead of the forthcoming changes’.
Also taking part in the session were Jamieson Thrower, NatWest’s commercial and private banking business lead for LIBOR transition; Olivier Gayno from HSBC Global Asset Management; David McNally, a director at Deutsche Bank; and Edwin Schooling Latter, director of markets and wholesale policy at the Financial Conduct Authority (FCA).
For Boyce, the entry point into the discussion was the importance of taking action to adapt to forthcoming changes in borrowing agreements and derivatives contracts. “LIBOR is going to disappear, so you need a plan for when it does,” she said.
Schooling Latter set the scene by detailing the reasons behind the move away from LIBOR. “There are supply-side reasons for the move as well as demand-side reasons,” he explained. “On the supply side, there are issues in creating the rate: LIBOR measures a market that no longer exists. The market for term inter-bank borrowing used to be a common way for banks to fund themselves. But it just isn’t any more. It’s not sustainable to produce a benchmark measuring something that doesn’t exist in the way it used to – much better to have benchmarks that are grounded in actual transactions.”
From the point of view of businesses, Schooling Latter added, LIBOR is no longer the right rate for most borrowers. He said: “That’s because it exposes the borrower to an opaque and pro-cyclical risk of interest rates rising at times of economic stress. We got a reminder of that at the beginning of this year in March and April when the spread of LIBOR over SONIA (Sterling Overnight Index Average) increased to around five times its average over the previous five years.” This was a graphic illustration of why the move away from LIBOR should leave the non-financial corporate sector with interest rates that are easier to understand and less likely to rise at times of economic difficulty.
Schooling Latter also stressed that the FCA was committed to its previous schedule of phasing out LIBOR by the end of 2021 – and that this was not going to be delayed by the coronavirus pandemic. “The way LIBOR has behaved during the Covid-19 crisis has only served as a reminder of why we need to move on,” he said.
“Amid the coronavirus crisis and the end of the Brexit implementation period, the end of 2021 might seem to be some way off – and some businesses may therefore think the LIBOR transition is an issue for next year. But engaging with the transition is a task to be addressed now. In fact, the next two quarters are arguably the critical period for action.”
“Everyone who has a LIBOR-linked facility with a maturity date beyond 2021 needs to actively transition that facility to a SONIA basis. The preferred solution is to have a conversation with your lender to execute an amendment, which doesn’t touch any other aspect of that contract” Jamieson Thrower, commercial and private banking business lead for LIBOR transition, NatWest
The panel discussed how sterling lenders are now expected to offer corporate borrowers a non-LIBOR alternative rate. While for any businesses which do choose to borrow on LIBOR from this point on, lenders will need to put in place an agreement for how the rate will convert away from LIBOR at some point before the end of 2021.
For businesses that use derivatives, it was highlighted that the International Swaps and Derivatives Association (ISDA) is finalising a protocol setting out how derivatives contracts can be updated to take account of the LIBOR transition. This protocol is expected to become available at the start of 2021. That said, McNally pointed out that the SONIA derivatives market was well advanced and that trades already exceed the volume of LIBOR-based transactions.
He added, however, that the fallback clauses on most derivatives contracts applied only when a benchmark is temporarily unavailable – not when it has been permanently withdrawn. As such, businesses should get in touch with their swaps dealers once the new ISDA protocol has been published to establish next steps.
In terms of the action businesses need to consider now, NatWest’s Jamieson Thrower said: “Everyone who has a LIBOR-linked facility with a maturity date beyond 2021 needs to actively transition that facility to a SONIA basis. One way of doing this – arguably the preferred solution – is to have a conversation with your lender to execute an amendment, which doesn’t touch any other aspect of that contract.”
When it comes to derivatives, corporates need to engage with and sign up to the ISDA protocols, taking particular note of cessation fallback rates. When borrowing money, corporates should not assume that fallbacks in documentation are robust, and so the contracts need to be actively amended.