In July 2017, the United Kingdom’s Financial Conduct Authority (FCA) announced that financial institutions will no longer be required to publish LIBOR rates after December 2021, signaling the effective end of LIBOR. Given that the FCA provided a four-year transition period for market participants to identify and implement alternative reference rates, market participants are rapidly approaching the “fourth quarter” of the transition away from LIBOR.
Winning in the fourth quarter is more difficult when you finish the third quarter down by 28 points. And so, it is critical that institutions assess their progress to date in preparing for the cessation of LIBOR and making plans to implement an alternative reference rate. At this stage of an institution’s transition plan, a number of milestones need to be completed in order for an institution to reasonably consider itself “on-track.”
These include having the workstreams listed below and a detailed plan in place to complete the execution of these tasks over the next year:
- LIBOR Transition Project Team Established – Financial institutions should have established a dedicated project team responsible for managing the transition from LIBOR. For larger institutions with LIBOR exposure in multiple business units, business unit leaders should be identified and made responsible for LIBOR transition activities in their business unit.
- Identification of LIBOR Exposure – Legacy contracts should already have been evaluated and exposure to LIBOR products maturing beyond year-end 2021 should have been quantified. During the upcoming year, monthly and quarterly updates on LIBOR exposure should be communicated to management.
- Assessment of LIBOR Contracts – Contracts should be reviewed to determine whether clear fallback language has been incorporated. Contracts with a) clear fallback language, b) fallback language requiring legal interpretation, and c) no fallback language must be identified and inventoried.
- Remediate Contracts without Clear Fallback Language – For contracts without adequate fallback language, institutions need to identify and finalize options for alternative reference rates, remediation plans, and a communication strategy with stakeholders when LIBOR is terminated.
- Assess Financial Exposure to Alternative Reference Rates – Because institutions will likely be impacted by exposure to alternative reference rates beginning in January 2022, plans need to be in the works for performing analyses on how the new alternative reference rate is likely to impact income, funding, liquidity, and capital levels.
- Stop Use of LIBOR on New Products – It may not need to be said, but one of the most effective methods of mitigating LIBOR exposure is to stop creating new LIBOR products. To the extent new LIBOR products need to be issued, institutions must ensure that clear, easy-to-follow fallback language has been incorporated.
- Update and Remediate Technology – LIBOR is likely embedded in many applications and systems that set pricing on products, determine contractual payments, and determine the fair value for instruments. Plans need to be developed and implemented to update and test technology applications with LIBOR exposure.
Consider engaging with external data and technology vendors to ensure operational readiness to transition away from LIBOR. Each business line and core function such as Finance or Treasury needs to inventory technology, operations, and modeling tools to ensure every LIBOR touch point is properly accounted for.
- Validate Models With LIBOR Assumptions – As we discussed last month, many models rely on LIBOR as an assumption or as part of the cash flow discounting mechanism. Validators of models transitioning from LIBOR to an alternative reference rate need to account for this. And unscheduled validations may become necessary for models that might not otherwise be up for review before the end of 2021.
The cessation of LIBOR is a significant event impacting a broad set of financial products and market segments. Because it is intertwined in the products, technology, and models of a financial institution, LIBOR transition must be sufficiently planned, resources must be mobilized, and alternative reference rates must be implemented into every business and process.
The “fourth quarter” of the LIBOR transition game is upon us and the stakes are too high to rely on the second string. Financial institutions cannot underestimate the operational, technical, legal, communication, and risk management work required to move existing transactions off LIBOR and prepare for alternative reference rates. Although these efforts to transition from LIBOR should already be in full swing, they will continue to require additional time and resources. Teams that seem to be in control of the game still need to finish strong.
Financial institutions that have not begun a comprehensive LIBOR transition plan are running out of time and will need to mount a furious fourth-quarter comeback. It’s not too late, but with the last year of the LIBOR transition dawning, financial institutions that are behind in their planning need to hustle. No one can afford to lose this game. The costs of failing to prepare are simply too high.