Last editedDec 20212 min read
The London Interbank Offered Rate (LIBOR) is an interest rate benchmark, primarily used in financial markets since the 2008 financial crisis. It has been used around the world to determine the interest rates in financial contracts, but is now due to be phased out by the end of 2021.
The phasing out of LIBOR has been accelerated by the UK Financial Conduct Authority (FCA), with the FCA’s Chief Executive Andre Bailey stipulating that providers of financial services should transition to using alternative overnight risk-free rates (RFRs) by the end of the year.
However, transitioning from LIBOR to RFRs is a complex and time-consuming process which can create risks for both providers and users of financial services if it is not implemented correctly.
Here we discuss what the LIBOR transition means and how board members and executives can navigate their firms through the inherent problems that will arise from this immense transformation project.
Leading the LIBOR transition process
Implementing a successful transition that minimises the risks to both a company and its customers should be a measured approach that can be performed in four stages. These stages consist of:
Developing a cross-business unit collaboration strategy
Determining the transition timeline
Identifying risks and their potential solutions
Monitoring and maintenance.
Stage 1: Cross-business unit collaboration
At this stage it is crucial that C-level members of each firm direct the development of the strategy. Executives and other high-ranking corporate officials must lead the way and ensure they are personally aware of all the moving parts of the process.
It will be the responsibility of the executives to ensure each business unit within their business works in unison together to implement the strategy effectively. It must also be this C-level sponsorship of the transition programme which will define the firm’s approach to the transition process.
Stage 2: LIBOR transition timeline
Once the C-level sponsorship has ensured everyone in the firm and each business unit within the business is on the same page, the timeline and roadmap can be determined and outlined, and thus the LIBOR transition begins in earnest.
This stage will consist of several activities, starting with the identification of any and all financial exposures caused by the LIBOR transition.
After the financial exposures have been identified and mitigated, it is time to launch the new RFR products and start building RFR volumes. The back book and legacy trades will also need to be transitioned during this stage.
Once the RFR-linked products have been launched and the RFR volumes are beginning to climb, it is time to dismantle the LIBOR infrastructure and start closing down the LIBOR processes.
Stage 3: Risk avoidance and solutions
Beyond the previously identified financial exposures, there are some inherent risks that will require mitigating actions once the LIBOR processes start being switched off and the RFR products start replacing them. It is imperative that these problems are identified early and their solutions implemented effectively.
One of the main risks to be mitigated is customers being unwilling to transition to RFR-linked products. This can result in reputational damage for the firm, and may even lead to claims for redress being sought by dissatisfied clients.
Stage 4: Monitoring the LIBOR transition impact
Executives must also monitor the ongoing LIBOR transition impact on the company’s financial performance. The main concern here is that any negative LIBOR transition impact might cause shortfalls in the financial plans of the company, both short term and long term.
There will be a variety of ways to compensate for such an impact, with the unique activities of each firm determining the best way forward. With a proper monitoring strategy in place, there should be few surprises and thus it will be relatively straightforward to navigate through the shortfalls.
We can help
If you’re interested in finding out more about the LIBOR transition, or any other aspect of your business finances, then get in touch with our financial experts at GoCardless. Find out how GoCardless can help you with ad hoc payments or recurring payments.