LIBOR sunsetting: how to avoid elephant traps | Mitratech Holdings, Inc.

[author: Javier Gutierrez]

The official end of the use of the London Interbank Offered Rate (LIBOR) as the benchmark risk-free interest rate for banks and other financial institutions, at least in the UK, was scheduled for the end of 2021.

It would be reasonable to assume that would mean he is making banking history. However, in financial services, the picture is less clear-cut than one might imagine. The truth about LIBOR is that it is not going away, instead, even after this retirement date, it will remain a key metric for many institutions for some time to come.

Part of this complex picture is the result of how regulators around the world have approached the issue. They might have been tempted to impose a solution on their chartered banks in the past, but they recognized that the widespread use of LIBOR, in a $240 billion market, in various business applications – in contracts , instrument pricing and many more – meant that the most practical option would help the market decide which alternatives would be most effective.

To date, several LIBOR alternatives are in use. In the UK, the Sterling Overnight Index Average (SONIA), managed by the Bank of England, is the preferred option. In Japan, the Tokyo Overnight Average Rate (TONA) is the alternative to the Yen LIBOR. The SARON, Swiss Average Overnight Rate, becomes the norm in Switzerland.

In the United States, the picture is different. The Secured Overnight Funding Rate (SOFR) is accepted as an alternative to US dollar LIBOR, but adoption has not been universal. The “mood music” of US regulators remains centered on the abandonment of LIBOR. The reality is that six synthetic LIBOR patches, administered by the Bank of England, will remain for the next 18 months to meet the needs of those still using LIBOR.

The general stance across the world is that regulators expect their chartered banks to stop referencing LIBOR for new loans in the coming months. In the UK, that date was January 1, 2022. The use of LIBOR will decrease significantly in the coming months but will not disappear completely. This situation creates a series of problems for banks.

Added value of the global standard

The added value of LIBOR was that it was THE global standard, universally accepted by all. The situation is now more fractured and institutions will need to ensure that everyone involved in a particular transaction understands which reference rate is being used. A reference rate may vary by country, client, product or type of instrument.

In addition, regulators now expect “new loans” to be LIBOR-free. The question here is what constitutes a “new loan”? Does renewing a loan without changing its LIBOR terms constitute a new loan? What about transactions that are part of a larger LIBOR-based contractual framework? Another problem arises when transactions are initiated outside of the major markets (US, UK, Europe or Japan). Will they stay at LIBOR or will they use another benchmark, if so which one?

In short, while moving away from LIBOR eliminates some problems, it also creates significant operational risk issues for many institutions. Many of them have already invested heavily in identifying and mitigating transactions, contracts and documentation that reference LIBOR and in developing new systems and processes that highlight their preferred LIBOR alternative. Unfortunately, the number of alternatives to LIBOR and the continued availability of LIBOR itself give rise to potential operational risk issues, particularly long-term risks, where exceptions remain after the official transition ready to catch the unwary. .

Use of spreadsheets to facilitate data entry and management

A standard response for busy operations teams to this kind of complexity is to use spreadsheets, to help capture and manage data, without waiting for IT to modify their business applications to help solve the problem. problem. While quick and convenient, these types of spreadsheets very quickly become mission-critical, whether used in portfolio management, financial modeling, instrument pricing, or any other application.

These spreadsheets lack the change control and transparency found in other business computing applications, which means that errors and omissions can appear without anyone noticing until until it’s too late. Referencing the wrong risk-free interest rate could have profound implications for a transaction or an institution’s reputation. In many ways, spreadsheets are the perfect tool for ad hoc problems, but only if they are carefully controlled.

How to carefully control spreadsheets?

Create a spreadsheet inventory

This gives you a foundation to centralize how you manage and review your fleet of critical spreadsheets. An inventory also serves as a repository for essential documentation needed to define and control your master spreadsheets.

Monitor to minimize problems

Proactively monitor critical spreadsheets so that any changes made are transparent to everyone. This minimizes problems with missing data, wrong calculations and formulas, or outdated data.

The discovery phase

The discovery phase – is how companies locate the critical spreadsheets they need to manage data. The key here is to find the most important spreadsheets used. These can be defined by a series of parameters, such as who uses a file, how often it is modified, what other applications and data sources it is linked to and other relevant criteria. Obviously user input can be included here to refine the search criteria

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