LIBOR replacement strategies

The Alternative Reference Rates Committee (ARRC) held a virtual meeting in early December 2020 to address recent developments relevant to the LIBOR transition. The meeting included discussions related to the recent announcements from the Intercontinental Exchange (ICE) Benchmark Administration (IBA), the United Kingdom’s (UK) Financial Conduct Authority (FCA) and related supervisory guidance from US regulatory authorities in December 2020. Following these announcements, IBA launched a consultation on its plans to cease publishing LIBOR rates. Pending final confirmation of this consultation, these announcements jointly provide a clearer path for USD LIBOR cessation: a call for banks to stop issuing new USD LIBOR contracts as soon as possible, and no later than end of 2021, as well as a concrete cessation date subject to the IBA consultation outcome. The ARRC also led a group discussion with current ARRC Members covering their issued best practices. There was a consensus that the best practices timelines and guidance were in line with the wider effort from the IBA, FCA, and US regulators.

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As the December 2021 deadline for the discontinuation of LIBOR approaches, US financial institutions and regulators are preparing for a transition to alternative reference rates. Banking and securities regulators have made LIBOR transition a supervisory priority for 2020 as noted in their respective communications.

On July 1, 2020, the Federal Financial Institutions Examination Council (FFIEC) issued a Joint Statement on Managing the LIBOR Transition (Joint Statement). Notably, this is not issued as supervisory guidance, but rather a statement that lists a range of LIBOR transition considerations.

On July 1, 2020, the Office of the Comptroller of the Currency (OCC) issued its bulletin (2020-68) which expanded on the FFIEC statement by providing banks, particularly community banks, with additional guidance for identifying applicable risks, planning, and successfully transitioning to replacement rates.

In their fall 2019 Supervision and Regulation Report and Semiannual Risk Review, the Federal Reserve Board (FRB) and the OCC, respectively, identified the LIBOR transition as an examination priority for 2020. The regulators encouraged firms to be aware of implementation dates, vendor management, and data implications of the transition.

Explore the key takeaways of these communications as the LIBOR discontinuation deadlines approach.

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Taking a backseat approach isn’t part of the genetic makeups for leading banking and financial institutions. Those leading the charge are in the driver’s seat, steering swift decisions that proactively help their clients and shareholders thrive. So it was no surprise when our client, a global investment bank, wanted to pave the way through the impending transition away from LIBOR with a smart, enterprise-wide solution.

Facing several key challenges related to their contract management, our client knew that a combination of off-the-shelf technologies wouldn’t suffice. Instead, they wanted a solution powered by artificial intelligence (AI) that would help them dramatically increase efficiency and visibility and scale with their business. After our client learned about our dTrax tool, they asked us to act as a co-pilot for their transformation.Learn how we helped them gear up for the change.

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On August 27, 2021, the Alternative Reference Rates Committee (ARRC), released a list of frequently asked questions (FAQ’s) on the best practices recommendations related to the scope of use of the Secured Overnight Financing Rate (SOFR) term rates. The FAQ’s build on the ARRC’s formal recommendation of the Chicago Mercantile Group’s (CME’s) SOFR Term rate announcement in late-July 2021. Specifically, the ARRC supports the use of SOFR Term Rates in situations where the use of overnight and averages of SOFR has been shown to be difficult, for example in business loan activity. The ARRC does not support the use of SOFR Term Rates for almost all derivatives products because these markets already leverage SOFR compounded in arrears. Transitioning to the more robust overnight risk free rates (RFRs) is a main component in developing the depth of transactions necessary in the underlying derivatives markets to construct the SOFR Term Rate over time. The FAQ’s also highlight some considerations and recommendations for “end-users” including supporting the end-users’ use of SOFR Term Rate derivatives to hedge their cash products that reference SOFR Term Rates. The ARRC considers an end-user to be a direct party (e.g. a borrower or a lender) to a SOFR Term Rate product such as a business loan, securitization linked to a SOFR Term Rate product, or a legacy product with fallback language or legislative directive that converted a legacy product to a SOFR Term Rate product.

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While repapering contracts is not a new phenomenon, financial institutions may face a colossal task of identifying and inventorying the contracts that need to be transitioned from LIBOR to alternative reference rates (ARRs) in a timely manner. Replacing LIBOR will impact a significant number of financial agreements. Identifying impacted agreements across many products and business areas, understanding remediation approaches, and analyzing the terms of the agreement for fallback provisions will require a significant amount of work and risk.

Given the volume of contracts that reference LIBOR and the uncertainty around fallback provisions, a manual approach to scoping, outreach, and remediation could result in a significant amount of cost and risk. The use of technologies such as artificial intelligence (AI), natural language processing (NLP), and online platforms for generation and negotiation of contract amendments can help make the transition more achievable. Leveraging these technologies can provide organizations the opportunity to scale, understand the content of agreements, and provide a more informed outreach to counterparties.

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