Panel session – challenges related to the replacement of IBOR

Yolaine Kermarrec, EY

David Minarik, Citi

Veenu Mittal, EY

Chris Palmer, JP Morgan

Yolaine moderated a panel discussion with industry experts on how banks are addressing the challenges they are facing as a result of the transition IBORs. The panel discussion focussed on IBOR programme governance, responses to what the industry refer to as the “Bank of England Dear CEO letter”, business and accounting impacts and views on the initial adoption of alternative reference rates.

Click to hear from Yolaine

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Bank of England Dear CEO Letter on firms’ preparations for transition from LIBOR to RFRs

“The Dear CEO letter was the fuel to power start IBOR programme at a number of market participants. It was a game changer because it really put the large banks and insurers on the hook to put formal governance programmes in place and overcome the inertia that was in the market.”
“Market participants not directly targeted by the Dear CEO Letter were specifically asked by the UK regulators to take note of what the letter required firms to do.”
“We do not believe that the Dear CEO Letter is a once-off request, so a major challenge is developing a sustainable process for identifying and reporting our exposure to LIBOR.”
“Our approach is to include anything that is under the governance of the PRA or FCA from a legal entity structure point of view in our response to the Dear CEO Letter. We are focussing on the five major currencies and only LIBOR exposure. Trying to segregate and aggregate the information by legal entity is a challenge.”

Programme governance

“Our IBOR programme is managed in a federated way, with each business responsible for their own implementation and their own budget, but with oversight from a central committee.”
“2018 is for education, 2019 for building and 2020-2021 for implementation and execution”

Market adoption of ARRs and regulatory development

“We are looking at three primary scenarios for LIBOR transition:
  • Firstly, a cliff edge scenario where LIBOR comes abruptly to an end on 2 January 2022
  • Secondly, a managed transition by the regulators and a gradual decline by submitters over a period of between 3 to 24 months, and
  • The final option is one where banks continue to submit and LIBOR persists. We have to plan for all three, but our preference is for a managed transition.”
“Not doing your part on EONIA and EURIBOR transition by believing that a delay will somehow be delivered would be unwise.”
“There is an advantage to be gained from being the best to move, not the first to move. It is critical is to increase awareness and educate market participants on transition, and respond to, rather than creating, a market demand for new risk-free-rate linked products. There is growing but still limited interest in alternative risk-free rates. Most activity at the moment is in the markets for SONIA and SOFR linked products."
“The greatest risk that we run with respect to IBOR transition is conduct risk. For example, one of our competitor’s may behave in a way that spooks the market and inhibits the adoption of alternative risk-free rates. This is a risk that we cannot control.”
“The only appropriate way to approach IBOR as a client facing entity is to ask the question how best do we help our clients manage the transition?”

Business and accounting impacts

“The first question from our client base is: when are term rates going to be available for alternative reference rates? Building term rates and developing the conversation around terms rates is the number one way to get the transition moving.”
“New issuances linked to alternative reference rates will aid adoption. For example, Fannie Mae recently made two big issuances referencing SOFR but some of this was swapped back into LIBOR so it is ceremonial to some degree.”
“Large corporate clients are very interested in establishing what the different legal fall-back mechanisms are for specific products. It is expected that for derivatives, legal fall-back mechanisms will be covered by the International Securities and Derivatives Association (ISDA), but for both syndicated and bilateral loans the process is less clear. Do clients have to renegotiate each contract one by one and at the same time?”
“Regarding hedge accounting, the US Financial Accounting Standards Board (FASB) may have largely solved the hedge accounting issue, perhaps not intentionally, with new rules that say the hedged risk can be changed with the continuation of hedge accounting, as long as the hedge is still highly effective. They also just added SOFR in the list of benchmark rates which can be used for hedge accounting. Without guidance from the IASB, there is a risk of diversity in practice, which may not be not useful for the users of the financial statements. I am optimistic that the IASB will solve it one way or another.”
“Valuation is a key work-stream. Potential fair values transfers from Level 2 to Level 3 could have a capital impact. The capital impacts of IBORs discontinuation remain broadly under explored.”