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From IBORs to risk-free rates: so many questions, so little time

From IBORs to risk-free rates

With a little over two years to go until the transition from interbank offered rates (IBORs) to risk-free rate benchmarks, how prepared is the banking industry?

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Haji Karim

Head of Financial Services, UK, Partner

KPMG in the UK

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From IBORs to risk-free rates: so many questions, so little time  - tower clock

Time is starting to run short. It is almost two years since the Financial Conduct Authority announced that after 2021, banks would no longer be compelled to submit data to the London Interbank Offered Rate (LIBOR). There is now a little over two years to go until we’re due to make the transition from Interbank Offered Rates (IBORs) to the risk-free rate benchmarks (RFRs) based on transactional data to which regulators intend to switch.

Halfway there then, more or less. Yet while the direction of travel is clear, there is still significant uncertainty about how each jurisdiction will make the leap from IBORs to RFRs. With each geography plotting its own course, visibility is fuzzy – both of the precise timeline for the journey and of the precise final destination.

However, we do not have the luxury of waiting for clarity. The scale and complexity of the task – the Financial Stability Board estimated in 2014 that more than $370 trillion worth of notional contracts used LIBOR, EURIBOR or TIBOR as a reference rate – is too great for delay to be an option.

At KPMG, we’re working hard with clients, peers, regulators and other stakeholders to move forward. Our recent LIBOR Week, a series of roundtables and events designed to identify potential challenges and practical workarounds, underlined the need for all parties to step up their transition planning. Six big questions in particular stood out for us at the end of the week:

1. How will we make the transition?

Are we going for a big bang approach to the switch from IBORs to RFRs, or will the transition be more gradual, taking place over an extended period as existing contracts mature? Either way, market participants will need to look at the detail of existing contracts; while some contain fall-back rates in the event the IBOR is not available - those that don’t may require repapering or will need changes to the fall-back clauses.

2. What are term structures going to look like?

RFRs are overnight rates, but many market participants, particularly in the corporate sector, currently utilise a range of term structures for the contracts they employ. It’s not yet clear when and how these term rates will be constructed – there is as yet no guidance on methodology or how we will ensure sufficient liquidity.

3. How will corporates cope?

The financial services industry isn’t the only group of businesses affected by this transition, with significant numbers of large (and not so large) corporates dependent on IBORs too. While we may be able to manage bulk transactions in mature and sophisticated financial markets, this will often not be possible for individual corporates with IBOR exposure. They will require significant support.

4. Is LIBOR actually going to disappear?

While 2021 is supposed to be the final year of regulatory support for LIBOR, it’s still not clear this is practical. The long tail of contracts maturing after this time are likely to need ongoing support and published data.

5. How do we get corporate engagement?

For many non-financial businesses, the move from IBORs to RFR is a headache they could do without, particularly since they have lots of other priorities. The discussion so far has often been technical and framed from the perspective of financial services businesses; getting corporates involved and engaged is now a key challenge.

6. Can we mitigate conduct risk?

Shifting from a system that participants are used to and understand well to a completely new way of working will inevitably create winners and losers. The transition must be fair and transparent to avoid accusations of conduct risk.

Against this backdrop of unanswered questions, the transition work is continuing – as it must do if the market is going to be ready by the end of 2021. What does your planning process look like today? Does it include all of the following:

  • Contract identification – of all products and business lines, including expected fall-backs and the potential need for repapering.
  • Client outreach – early communication with customers about what this process now.

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