Wade through the LIBOR transition journey with Atos|Syntel
The London Inter-Bank Offered Rate (LIBOR) is a widely used interest rate benchmark that is offered in 5 currencies and 7 maturity rates (from overnight to 12 months). The U.K. Financial Conduct Authority (FCA) has recently announced that it will phase out support for LIBOR at the end of 2021, and banks will no longer be allowed write contracts using LIBOR after that point.
Instead, risk-free rates (RFRs) will be published to replace LIBOR in the 5 currencies below:
The proposed RFRs are different from LIBOR, and should not be considered a one-for-one replacement. There will be significant challenges in the transition from LIBOR to risk-free rates, including:
- RFRs rely on historical transaction data, while LIBOR is a forward-looking rate
- RFRs are published only as overnight rates, while LIBOR offered a range of maturity periods
- Ongoing loan agreements must be amended with fallback provisions to support new risk-free rates
- A large scale transition of synthetic loan agreements to support the new risk-free rates will be required, involving a consortium of banks
- Accrual calculations for floating-rate instruments must be changed following the transition from LIBOR
Unlike LIBOR rates, which are all published simultaneously, each Risk-Free Rate is published at a different time. Hence, existing systems must have the ability to pick-up those rates as they are published and pass them on to internal business functions.
|RFR||Publication time||In advance/arrears|
|SOFR||Around 8:00 am the next business day||In arrears|
|SONIA||9:00 am the next business day||In arrears|
|TONAR||10:00 am the next business day||In arrears|
|ESTR||By 9:00 am the next business day||In arrears|
|SARON||At 6:00 pm the same business day||In arrears|
Securities that refer to LIBOR term rates now must refer to the overnight rates. Since LIBOR is a forward-looking rate, it enables us to know the coupon payment at the end of the interest period with certainty. However, since overnight rates change every day, it is difficult to know the exact coupon amount before the payment date.
The Financial Stability Board (FSB) has recommended multiple mechanisms to ensure that security holders know the liquidity flow in advance. Below is an example of the lag mechanism, in which the coupon payment start date is delayed from the interest rate period. With this, we can predict the cash flow a few days before the coupon end date.
The FSB has proposed different mechanisms shown below.
At Atos|Syntel, we are working with clients to wade through the LIBOR transition program. Our Capital Markets consultants work with leading financial companies and provide the following services:
- Analyzing the impact of LIBOR rates and the transition to risk-free rates on existing products
- Developing LIBOR transition project roadmaps that encompass business areas like security services, treasury, derivatives, credit and banking and regulatory reporting
- Automating contract amendments and fallback provisions
- User acceptance testing for updated processes within business areas referring to the risk-free rates
You can visit our Capital Markets page to learn more about our services.
Vidyashankar is a Senior Consultant at Atos|Syntel. He has over 8 years of consulting experience in the Capital Markets domain delivering strategy, roadmaps, business cases and business consulting.