LIBOR Reform - A real uncertainty for corporates?
June 07, 2019
My many discussions with corporate treasurers on LIBOR reform have revealed a range of approaches ranging from “this is a storm in a tea-cup” to “I need to put considerable effort into this” Of course each corporate is different so I suppose its reasonable to expect a range of responses but my view is that as issues become clearer more treasurers will highlight the uncertainty LIBOR reform can cause them.
So what are the major concerns and what should corporate treasurers consider doing now to mitigate their risk?
Firstly, the alternative reference rates likely to replace LIBOR will differ by region, currency, tenor and basis making the transition especially complicated and time consuming for those organisations exposed to more than one new alternative rate.
Secondly not all of the alternatives are forward looking. For example GBP LIBOR is a forward-looking term rate with a range of seven maturities up to a year, whilst SONIA the proposed alternative is a backward-looking overnight rate. Many corporate treasurers I speak to hold the view that a transition away from LIBOR is dependent upon the development of forward-looking term structures. Essentially they need to know at the beginning of each current interest period the exact rate at which they are borrowing or lending. The availability of forward-looking term benchmark rates would certainly ease some of the operational challenges transitioning to alternative rates such as SONIA. Hence these corporates are focussed on ensuring there is suitable fall back language in existing contracts as well as reducing the potential basis risk that could arise between their various financial contracts as they navigate their transition to the alternative reference rates.
Thirdly, there are many aspects of LIBOR replacement that remain unclear as thinking continues to develop. The accounting treatment for changes to LIBOR based instruments and hedge relationships is one example. Indeed certain key unknowns may not be resolved until the final few months before the transition as new industry norms become clear. Corporate treasurers, therefore, need to develop plans now that set out how their organisations will move towards these alternative rates and then refine them as the industry and regulators clarify the biggest unknowns.
These are just the major issues currently being discussed around this topic – I am sure others will emerge as the transition progresses. I will update this blog periodically as options become clearer.
For further information on actions corporate treasurers should be including in their transition plans please see our publication Planning your LIBOR Transition. Also available is our latest IFRS Talks podcast on LIBOR Reform which explains the accounting reliefs proposed by the IASB in their exposure draft to help address some of the more immediate hedge accounting issues.