LIBOR is London Interbank Offered Rate, the benchmark rate in nearly $350 Trillion worth financial products contracts worldwide. Financial institutions have to completely transition away from LIBOR by the end of 2021. SOFR (secured overnight financing rate) has been developed as the alternative Risk Free Rate in the US, which should be adopted by Financial Institutions in the next few months. The transition to new RFRs have already begun in many geographies: Switzerland (SARON), UK SONIA), EU (ESTER), Japan (TONAR). Many financial institutions are struggling to keep up, and for many of them, hitting these deadlines is unlikely.
Read on to find out more about this transition and what financial institutions can do to accelerate.
American Bankers Association says that some banks just are not thinking about reference rates all right now. Libor’s market relies on estimates submitted from a small and rapidly decreasing number of banks who will only be able to submit those quotes until Dec. 31 of 2021. After that time, it is likely that Libor will cease publication causing a considerable risk to banks and customers alike.
Although it is advisable for companies to transition sooner rather than later, the process is easier said than done. Here are some common challenges organizations face:
- There is no “one size fits” all solution
- The transition requires a high administrative overhead
- There is no room for error. Since alternate RFS are not economically equivalent, missteps are likely and could have financial implications for banks and customers.
- There are difficulties in defining the benchmark rate for new and historic contracts which lead to complications in day to day operations
- The complex transition with multiple possible failure points could lead to a sudden lack of transparency in customer relations.
Despite challenges, a study conducted earlier this year showed that 90% of the firms analyzed had already begun the process of transitioning away from Libor with the largest and most internationally active making the most progress. Smaller firms and their executives, on the other hand, seem to be struggling.
Experts warn that it is best not to wait until the big boys have figured it out and follow suit. Everyone needs to get on board and the sooner the better. Here’s hoping your firm is prepared for this transition in the coming year.