Below is a summary of some of the main considerations:

   

 

Risk management

Maintaining a holistic understanding of the extent to which corporations’ reference, and thus are exposed to, changes in IBOR is an important first step for identifying and prioritising tasks for the transition to the replacement rate

 

 

 

 

Take Action

Evaluate the suitability of the new RFR, taking into account the industry discussion on the construction of the curve across maturities

Evaluate the impact on the value of the cash flows to be settled after the reference rate changes

Construct a strategy to be taken with regards to legacy portfolios: can they remain referenced to the benchmark rate should some form of the benchmark remain in existence after 2021, or do they need to be fully converted to refer to the new RFR?

Understand the tools in place under contract to absorb any mark to market movements upon transition

Operational readiness and compliance requirements not appropriately identified

 Take Action

The wider impact of the transition, including operational issues and existing regulatory rules, can lead to delays

Changes to a corporation’s operating model are expected to be significant given the extent to which existing benchmark rates are likely to already be embedded in systems and processes. Corporations should identify and evaluate sectors where there are IBOR dependencies and likely complications when meeting regulatory changes, such as a lack of liquidity in new RFR or legacy IBOR benchmarks that may have an impact on the use of internal models to calculate regulatory capital requirements.

Ensure sufficient time and resources are provided to identify and undertake the necessary operational changes

Ensure that the broader impacts, such as margin requirements and the Fundamental Review of the Trading Book, are evaluated in the initial impact assessment

Ineffective industry action

Take Action:

 Ineffective industry action that results from the lack of a regulatory or legislative mandate for the transition may lead to delays and possibly even sanctions

With a lack of regulatory or legislative mandates in place to support the transition, the responsibility for proactive engagement has been placed on the shoulders of market participants. Should corporations fail to engage, they may miss important market opportunities or face regulatory intervention, including sanctions, if authorities deem that they have failed to manage risks effectively or act in the best interests of their clients.

 Educate senior stakeholders on the importance of mobilising and funding a programme of evaluation and transition

Engage with industry working groups, central banks and regulators

Document all plans and maintain progress dashboards for use in engagements with stakeholders

Hedging

 Take Action:

 Should the new RFR not be co-opted across all financial contract types, a mismatch may arise between a derivative and the underlying hedged exposure: for example, should a corporation issue variable rate debts linked to GBP LIBOR, which is then hedged using GBP LIBOR IRS. Where hedge accounting is adopted by corporations, this mismatch may also lead to a broken hedge and the requirement to make a variety of accounting entities, thus increasing volatility in the P&L as a result of interest basis differences.

It is imperative that companies undertake an impact assessment of their current economic and accounting hedges to better comprehend their potential exposure, raise awareness of the impact of the transition, and prioritise their next steps.

 For hedge relationships designated as a cash flow hedge of the IBOR, understand whether the cash flows beyond 2021 can be considered as being “highly probable”

 Consider whether the relationship should be treated as a continuing hedge relationship upon transition to the new RFR or whether it will be necessary to redesignate as a new hedge relationship 

Evaluate the impact on inter-company funding trades and reconciliation processes

Systems, processes, and controls

 Take Action:

 The transition will require modifications to a whole swathe of internal controls, systems, and processes

 Trade capture and booking systems shall require updating to reflect the booking of trades that reference the new RFR and will need to capture the risk correctly within derivative accounting and valuation tools, risk management, and collateral systems 

Adapt payment systems to reflect the change in reference rates. Impacts can be expected on key reconciliations, such as Nostro and cash reconciliation

Corporations maintaining inter-company loans & deposits referencing the IBOR will need work out the impact on inter-company funding arrangements and the infrastructure for inter-company funding reconciliations

Frontline employees lack training and awareness

Take Action:

 Poor client service and unknown, unintended internal consequences may well result from a lack of employee awareness of the issues

 Uncoordinated and ineffective training regarding new RFR products are likely to lead to conflicting messages from the differing business departments. Front line employees may furthermore promote products in a way that is not aligned to corporate strategy, or one business area may switch to an RFR without considering the implications for the wider corporation.

Implement an internal communications strategy

Decide whether to roll out company-wide training programmes, best-practice strategies, and a red-flag system that outlines those issues that should trigger an escalation process by employees

Debt finance

Take Action:

The raising of finance through the loan and bond markets is expected to be hugely impacted by the transition from the benchmark rate. Whilst the impact of the transition on these markets will be the same, the measures to address them may well differ.

 For loan agreements, additional provisions in existing legal documents could substantially ease the burden of transition. However, the RFR may create difficulties in transitioning to a replacement rate which has yet to be fully tested as a forward-looking rate.

The debt issuance impact may be divided into existing debt issuance that would require concurrence with bondholders to modify existing terms and conditions, and new debt issuance, where corporations should be aware that variable rate lending issued today but due for redemption post 2021, will change after that date.

Insufficient liquidity of RFR products

 Take Action:

Insufficient RFR liquidity makes it difficult to build a yield curve and price products

 Companies may be unable to build a curve and price products effectively due to a lack of liquidity, giving rise to customer as well as counterparty complaints in the future and, in addition, to issues for the corporation itself in regards to appropriate hedging.

Evaluate and monitor the liquidity on legacy IBOR and new RFR-linked products across jurisdictions and confirm whether there is a need to add to RFR liquidity by issuing further RFR-linked products

Assess whether a term rate is essential for all parts of the market

Conduct risks inappropriately managed

Take Action:

Information asymmetries, inadequate disclosures, and conflicts of interest give rise to conduct risk

Transitioning the reference rates for products may potentially lead to some losing out, with one party paying or receiving more or less than the other. Should the process not be managed appropriately, complaints by customers of unfair treatment will inevitably rise. This risk will only be heightened as corporations are likely to have a more in-depth insight than clients into the advantages and disadvantages of the transition.

Have a programme in place to distinguish between customer types

Establish a clear client communication strategy and ensure customers fully comprehend the risks they may face during and after transition

Ensure all client disclosures are clear, transparent, and not misleading

Contractual language insufficiently vigorous

 Take Action:

Reliance on existing fallback language gives rise to legal risk.

As the methodologies for calculating IBORs and RFRs differ, modifying legacy contracts in reference to RFRs could result in one party being financially advantaged over another. This will lead to a risk of contract frustration should provisions in standard-term legacy contracts, which will become unsuitable following the RFR adoption, not be updated to provide robust protection. 

Review the contractual language used and amend them as necessary to address the discontinuation scenario

Tax issues arising from contract modifications

 Take Action:

 The transition of contracts to alternative RFRs may have tax ramifications should the implications of the amendments not be given due consideration

 If considered of material importance, changes to existing contracts could constitute a disposal of the existing contract and an entrance into a new contract for corporate tax purposes in certain jurisdictions.

Consider whether tax events would be triggered by existing terms and conditions

 Identify tax implications associated with repapering and review amendments to contracts together with the envisaged accounting treatment

Review any new intra-group arrangements from the perspective of transfer pricing

 

IBOR home

 

Background

     What is IBOR?

     Risk-Free Rates replace IBOR

     Current IBORs

     Stakeholders to the change

     What do we know about what is changing?

 

Major currencies

     Detailed list of known IBORs and their changes 

     Impact on Hong Kong (Hong Kong Dollar)

     Impact on Singapore (Singapore Dollar)

     Impact on UK (Pound Sterling)

 

Delivering change

     Post-IBOR insurance

     Post-IBOR banking

     Post-IBOR investment

     Implementation roadmap

     Contract changes

     Delivery management recommendations