BACKGROUND

It is well-known that the financial crisis, and then the rate manipulation scandal of 2012, revealed large-scale inadequacies in the interbank offered rates (IBORs).  

But despite steps taken to strengthen the benchmark rates, including oversight transfer to the Intercontinental Benchmark Association (IBA), global regulators have agreed on the transition towards alternative risk-free rates (RFRs).

Industry groups, comprising public and private sector representatives, were appointed across the different global jurisdictions and tasked with identifying the replacement benchmark rates.

See a summary of the key IBOR replacement rates below.

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THE END OF LIBOR

In 2017, to provide a catalyst for the migration away from LIBOR, the FCA stated that they would not compel panel banks to submit to LIBOR beyond the end of 2021[i].  An end date provided market participants a schedule to plan to and the five-year run-up period was deemed sufficient time for such a complex, heavy transition.

On March 5th 2021, The FCA announced the official cessation dates[ii] for all of the LIBOR currency tenor settings, confirming the proposals made by the IBA in their 2020 consultation.  All GBP, EUR, JPY and CHF LIBOR rates would cease at the end of 2021, as would USD one week and 2-month tenors.  

The remaining 5 x USD tenors would cease in June 2023 – the 18 month extension designed to enable the maturation of legacy contracts only.

The FCA announcement was confirmed by ISDA to constitute an index cessation event under the IBOR Fallbacks Supplement and as a result the fallback spread adjustment published by Bloomberg was fixed as of March 5th 2021[iii].

WHAT’S HAPPENED SO FAR?

See a summary below of the key IBOR milestones, past and pending.

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CURRENT STATUS

Despite the cessation date for most rates set for the end of 2021, LIBOR remains one of the predominant interest rate benchmarks across global markets.  The Bank of England Financial Stability Report[iv] from August 2020 estimates approximately US$400 trillion of financial contracts reference LIBOR rates across the five major currencies.

In January 2021, ISDA published their Transition to RFRs Review[v], which analyses the trading volumes of OTC and ETD interest rate derivatives using alternative RFRs. It reported that whilst traded notional in RFRs has increased through 2020, RFR-linked IRD products still make up less than 10% of total traded volumes in Q4 2020.

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WITH LESS THAN A YEAR TO GO UNTIL THE CESSATION OF KEY IBOR RATES, THE STATISTICS SHOW THAT THERE REMAINS A HUGE AMOUNT OF WORK LEFT TO BE DONE ACROSS THE INDUSTRY TO TRANSITION AWAY FROM IBOR BY END OF 2021.

It’s well-known that IBOR rates are deeply-rooted within the current infrastructure of all firms, both IT and operational.

IBOR is engrained across key functions for a wide spectrum of usage. Some of those impacted functions and key IBOR use cases are detailed in our visual below.

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THE CHALLENGES

The reality is that the vast majority of firms will require front-to-back, cross-functional change to transition away from IBOR over coming months.

The transition from IBORs to RFRs is one of the most complex, high risk, post-crisis industry initiatives that we have seen to-date. 

But IBOR transition has been complicated even further by the COVID-driven deferral of other key regulations, such as Phases 5 and 6 of Initial Margin and the CSDR Settlement Discipline rules.  

As a result, throughout 2021 and early 2022 we now find ourselves in the midst of an unprecedented regulatory bottleneck across post-trade domains.

Subsequently, firms are having to deliver multiple, heavy regulatory programmes in parallel, with already-stretched teams. 

During this time, we expect most firms to experience resource capacity issues to drive through all required transformation.

This makes it increasingly tough for firms to make the quick and effective decisions needed to define and deliver suitable long-term strategies, solutions and target operating models. 

On top of that, there are a significant number of additional IBOR challenges for all firms. See a subset of those key challenges below.

COLLATERAL CHALLENGES

Collateral is one of the functions that will be aggressively hit by IBOR transition.

Collateral IBOR challenges are driven by the renegotiation of existing contacts and consumption of the RFR data into key systems.

The need for legal renegotiation of OTC trading contracts away from the IBORs is widely publicised.  ISDA launched their protocol document in October 2020, which enables firms to incorporate revisions into their legacy non-cleared trades with all counter-parties who sign up to the ISDA protocol, through the execution of a single artefact.  As of January 25th 2021 when the fallback revisions went live, more than 12,000 entities across nearly 80 jurisdictions had adhered to the ISDA protocol[iv]. 

Unfortunately, no industry mechanism exists to update the terms of key collateral documentation (e.g. CSAs, GMRAs, GSLAs, etc), which must instead be renegotiated and executed bilaterally. This brings its own set of challenges….

For example, renegotiating interest accrual terms on cash collateral will alter the valuations and economics of the underlying trades, meaning pricing curves should therefore be amended at the same time. This requires firms to negotiate, agree and settle any associated cash adjustments triggered by the rate changes under the collateral agreements.  

Another challenge is that most collateral systems will be unable to handle different rates applied to the same collateral agreement within the same accrual period. This means that careful coordination is required to agree rate amendments and process cash adjustments, to ensure no impact on BAU processing. For that reason we often we see firms preferring to perform their transitions over month-ends, with the new RFR applying from the start of the next month.

Clearly key data feeds used by collateral and all other functions will also require updating, which will need careful management to ensure no negative knock-on effect to various batch processes and BAU.

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HOW CAN TONIC HELP?

At Tonic we are genuinely expertise-led across all post-trade domains, including IBOR. 

Our industry specialists also hold deep experience in successfully delivering complex change for key post-trade regulations, across both the sell-side and buy-side.

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But what does that expertise actually mean for IBOR? 

We already come armed with the toolkit to accelerate the right solution decisions and delivery for our clients, ensuring a successful IBOR transition and minimising any business impact.

Bearing in mind the time and capacity constraints all firms will experience, the speed of effective decision-making will be a critical success factor in any IBOR transition programme.

We have extensive experience delivering and leading front-to-back cross-functional regulatory change programmes to global clients.

We leverage our expertise to deliver fit-for-purpose solutions that minimise the commercial and operational impact of IBOR transition for our clients. 

Our specialists have been here many times before, quickly understanding the client’s requirements and sharing all available options for strategy, target operating models and vendor solutions to meet the client’s IBOR objectives.

In addition, we open up our full post-trade industry network to our clients, including vendors, market participants and industry bodies. This allows our clients to further accelerate both the right IBOR decisions and their delivery.

TONIC IBOR APPROACH

We provide a flexible set of modular IBOR services, tailored to our clients’ needs.

This means that, regardless of the stage of your firm’s IBOR transition, our specialists can accelerate your readiness through the delivery of specific modules, by leading the full end-to-end delivery or taking on specific needs as they arise.

The key modules that we support are shown below.

TONIC IBOR HEALTH CHECK

At its core, the Tonic IBOR Health Check is an accelerated Impact Assessment to deliver our clients a single, aggregated view of their full IBOR scope. 

The IBOR Health Check is therefore a critical early deliverable for our clients to quickly move onto IBOR transition planning and solution decisions, which will be key to their transition success by end-2021.

The Health Check contains two key deliverables. Margin Tonic can lead one or both of these deliverables, as required.

1.       A deep-dive internal scope analysis across products, systems, functions and processes per IBOR 

2.      Client outreach exercise to confirm key programme assumptions and validate the IBOR approach per counter-party

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Once complete, the Health Check results enable our clients to gain a comprehensive view of their full IBOR delivery scope, right down to the lowest level of detail. 

Only then will firms be able to rapidly move onto planning their IBOR transition with confidence.