Some market participants are lagging in their preparations to transition to alternative interest rate benchmarks.
The International Swaps and Derivatives Association (ISDA) launched its interbank offered rate (Ibor) fallbacks supplement and Ibor fallbacks protocol in late October amid concerns that some market participants are lagging in their preparations to transition to alternative interest rate benchmarks.
The supplement amends ISDA’s standard definitions for interest rate derivatives to incorporate robust fallbacks for derivatives linked to certain Ibors, with the changes going live on January 25, 2021. From then onwards, all new cleared and non-cleared derivatives that reference the definitions will include the fallbacks.
The protocol means market participants can revise their legacy non-cleared derivatives trades with other counterparties that choose to adhere to the protocol and also become effective on January 25 next year.
Some 257 derivatives market participants adhered to the protocol during a two-week pre-launch period, among them the Bank of England. Nonetheless, there is a mixed picture of preparations, particularly with disruptions caused by the Covid-19 pandemic.
Date confusion
A recent survey published by Barclays bank, showed that 83% of 100 of its money markets and credit clients believed that Libor usage will cease by the end of 2021 or shortly after.
“A great deal of this has to do with the advent of financial technology that can mitigate the complexities of market structure from treasury rates, compliance regulations, and others including Libor,” says Paul Kaufman, a managing director at Broadridge Financial Solutions.
Any institution that does not have a proper governance structure in place… will struggle with their preparations for the cessation of Libor
But others see problems. According to Michael Koegler, managing principal at Market Alpha Advisors most US financial institutions will not be ready for Libor’s scheduled demise.
“Any institution that does not have a proper governance structure in place that includes board-level representation will struggle with their preparations for the cessation of Libor,” he warns, explaining that this cannot just be left to one department such as legal to deal with. “There are many factors involved in a successful transition that are interdependent,” he says. Nevertheless, many institutions have not taken a holistic approach to the task.
Smaller institutions left out
Another factor in the lack of preparedness is that many smaller institutions have been counting on getting their lead from major banks and then following in their footsteps, says Mr Koegler. But most of the big banks have been fully absorbed in their own preparations and have been reluctant to advise their smaller peers due to litigation fears.
Therefore many financial institutions are hoping that the UK’s Financial Conduct Authority will continue to require Libor panel banks to keep compiling the rates beyond the end of 2021. Mr Koegler describes “hoping for an extension” as a terrible strategy as the US regulators do not have any influence over the cessation of Libor.
Nonetheless, due to better preparedness and choosing an alternative benchmark banks are already familiar with, unlike in the US, the UK appears to be better prepared for the demise of sterling Libor than the US is for the end of dollar Libor.
This article first appeared in The Banker's sister publication Global Risk Regulator.
