Banks and the businesses they lend to are putting the brakes on preparations for the end of Libor, industry sources say, because they are too busy grappling with fallout from the coronavirus to deal with the complexities of interest rate benchmarks.
Global regulators have said they want to stick to the current end-2021 deadline for scrapping Libor, which is embedded in up to $340 trillion worth of financial contracts worldwide. Authorities decided to phase out the benchmark after finding some traders had manipulated it for profit.
But this timetable has put them at odds with banks which have diverted staff from Libor project teams because of the coronavirus and pared outreach initiatives to clients who were already struggling with the transition before the outbreak.
While derivatives markets are adapting to alternative benchmark rates efficiently, companies with Libor-linked debt are finding the changes more expensive and cumbersome.
Bankers who work with small businesses said many now have no time to work on Libor transition.
“Libor has just fallen way down the priority list, we are running a pilot programme for transition but it’s very difficult to ask companies to find the time to join it,” said a senior executive at one of Britain’s top banks.
If the coronavirus pandemic delays efforts to adopt Libor alternatives and regulators try to stick to their guns, then hundreds of billions of dollars of bonds, derivative contracts and loans will be tied to a benchmark that no longer exists.
This would create uncertainty for benchmark borrowing rates just as companies are rushing to shore up balance sheets and risk dislocating already strained money markets even further.
Lawyers said pushing back the 2021 deadline for ending Libor is fraught with problems, not least that it would require banks to continue submitting a rate that no longer reflects underlying trades and has caused them a decade of legal woes.
“There was already a view that this deadline was about as far back as you could go, pushing it back further would just mean … you make a bad problem worse,” said Marcus Morton, managing director at advisory firm Duff & Phelps.
“EXISTENTIAL PROBLEMS”
New research published by financial technology firm Finastra suggests the global banking industry faces a bill of more than $8 billion to be ready for Libor’s end-2021 swan song.
That takes into account costs of changing every Libor-linked contract the bank has, with big lenders typically expected to spend some $100 million, as well as upgrading systems.
Pedro Porfirio, Global Head of Capital Markets at Finastra, which provides loan pricing and valuation software to more than 80 of the world’s biggest financial firms, said it would be “very naive” to expect Libor transition to progress at the same speed as before the pandemic.
“If banks choose to spend money now on things like Libor transition – that do not directly support the real economy- the real economy is going to fail,” he said.
“They’re making sure they are operational, that their risk function is very focused and under control. The people in charge of this were the same guys dealing with Libor transition.”
Industry sources in the United States said work on transition projects had similarly been impacted by the pandemic.
“Buyside clients here were just starting to really focus on this in January-February of this year, and then all hell broke loose, and now they are focused on more existential problems,” said Miki Navazio, a lawyer at Seward & Kissel in New York.
Regulators in the United States have yet to indicate if they will relax some of the deadlines for implementing Libor transition, Navazio said, but are likely to follow Britain’s lead if authorities there do push back some of the milestones.
“We just focus on the facts as we know them. Obviously anything can happen – these are very challenging times – but from the information that we have today, it remains clear that we should be going down the tracks by the end of 2021,” said Tom Wipf, chair of the Alternative Reference Rates Committee (ARRC), which is working on the transition.
A spokesman for the Commodity Futures Trading Commission, which has been heavily involved in Libor transition, referred to comments published in March by its chair, Heath Tarbert. He wrote that regulators were planning “for all eventualities.”
Britain’s Financial Conduct Authority declined to comment. The Association of Corporate Treasurers did not immediately respond to a request to comment.
TIMELINE
Some industry sources said regulators should extend an October deadline to ditch new Libor lending by at least six months to relieve stricken borrowers and the banks and investors striving to issue new loans or emergency fundraising.
Britain’s FCA has hinted there might be some leeway on near-term milestones but the sources said regulators should also consider the end-game in greater detail. If the transition is not completed on time, there are questions as to whether banks should be compelled to continue submissions to the panel which publishes Libor.
“What banks need is more flexibility on the ultimate deadline,” said Porfirio, adding that this could mitigate the stress of ensuring all contracts had provisions for switching to another rate by end-2021.
The Financial Stability Board, which coordinates financial rules for the Group of 20 economies, on Tuesday said an unsuccessful transition would pose risks to the financial system and said it would discuss solutions in July.
Phil Lloyd, Head of Market Structure & Regulatory Customer Engagement at NatWest Markets (RBS.L), said with little visibility on how long the world’s economy might remain in lockdown, it was hard to plan around such a range of possible outcomes.
“Banks across the industry have had to switch focus…It doesn’t mean they think those reforms are less important but they have more immediate challenges to face,” he said.
Meanwhile, companies themselves have little doubt where their priorities lie, according to a second industry source familiar with how businesses are planning for Libor transition.
“The regulators want to keep the pressure on but this really is not the time to keep pushing it. It’s just one change too many, and the changes necessary are dramatic.”