For over four decades, the London Interbank Offered Rate (LIBOR) rate has influenced various parts of the finance industry, used as the key point of reference for financial instruments, such as future contracts, the U.S. dollar, interest rate swaps, and variable rate mortgages.
The global phase out of LIBOR has been gradual, yet impactful since the Financial Conduct Authority (FCA)’s announcement of its cessation in May 2021. By June 30 of 2023, the British pound (GBP), Japanese yen (JPY), Swiss franc (CHF), euro (EUR), and United States dollar (USD) LIBOR rates were no more.[1]
Despite newly implemented “synthetic” LIBOR rates extending into the end of-March 2024, asset management firms will need to perform heavy lifts to ensure that their front- and back-office systems are in line with changing global regulations. After all, the replacement of LIBOR with alternative reference rates (ARR) has impacted over $200 trillion in derivatives and cash contracts[2].
Contractual and Legal Implications
Compliance managers will need to review and amend all existing contracts and financial instruments that reference LIBOR. In a joint statement issued by the NCUA, CFPB, the federal banking agencies, and state regulators, a “new LIBOR contract” needs to include, “an agreement that (i) creates additional LIBOR exposure for a supervised institution or (ii) extends the term of an existing LIBOR contract.”[1]
The existing contract may need to have its definitions updated, certain language removed, or clauses added. The amendment will need to be presented to the other party, who will then need to agree to the terms, an effective date, and sign off.
For asset managers, the risk of alternative rates will need to be considered for interest payments, pricing valuations, and other contractual terms. This could be a time-consuming and complex process, particularly for contracts with longer maturities or those that do not include appropriate fallback language for the LIBOR replacement.
Risk Management
The LIBOR transition may introduce new risks or change the characteristics of existing risks in investment portfolios. The transition will inevitably lead to temporary disruptions and changes in market liquidity as pre-June 2023 total return swap contracts will still have cash flow payments tied to their original LIBOR-referenced value.[1]
Firms must identify and manage these risks effectively as they could lead to legal, operation, regulatory, and reputational damages.
Operational Adjustments
Overall, the LIBOR transition serves as a reminder to asset managers about the advantages of being proactive and well-prepared for regulation changes. In an everchanging, fast paced industry, it is imperative to be on top of regulatory requirements to avoid legal and reputational hits. IMP will continue to monitor the impact of the LIBOR phase-out and provide examples of how it plays out.
If you would like to learn more about how IMP is helping firms identify risks in a changing regulatory environment, please contact IMP professionals at www.impconsults.com.
Sources
[1] https://home.barclays/content/dam/home-barclays/documents/misc/CCP%202023%20FAQs.pdf
[1] https://www.nafcu.org/compliance-blog/interagency-statement-regarding-libor
[1] https://www.jpmorgan.com/solutions/cib/markets/leaving-libor#:~:text=On%20April%203%2C%202023%20%2D%20The,methodology%20until%20end%2DSeptember%202024.
[2] https://www.capitalone.com/commercial/solutions/libor-sofr/
