Interbank Offer Rates (IBOR) play a pivotal role in the functioning of financial markets. The transition away from IBOR represents one of the biggest challenges facing financial services firms. The reform has been ongoing for more than two years, during which market-infrastructure providers, regulators, buy- and sell-side firms, and trade associations have been assessing and preparing for a significant transformational effort.
This survey was conducted during a webinar hosted by Quantifi on ‘Navigating the IBOR Transition’. Over 350+ individuals from across the financial services industry registered for the webinar and were invited to take part in the survey.
How far along is your firm in your IBOR transition efforts?
Financial institutions must proactively engage with regulatory and industry-led efforts to analyse the complex challenges ahead and develop solutions to mitigate significant risks to their organisations. Successful management of the transition requires significant change and strategic risk management – from adjusting risk profiles and models to navigating an uncertain regulatory landscape. Firms need to understand the implications of different scenarios on their financial performance and delivery programme, and should have flexible delivery plans to be ready for different scenarios and have a clear understanding on potential impacts of each scenario.
Though 59% of firms have a formal transition plan, only 38% have begun implementing process, product, data and systems changes. Only 21% have partially deployed in certain products/units. The survey findings also show that a significant number of firms (41%) have made less progress and remain largely unprepared. These firms are only at the stage of assessing the impact of the transition on their overall business strategy. The results highlight that a transformation of this magnitude will be more complex than anticipated and that the approaches taken by firms is siloed and not integrated across business lines and with technology functions. It is therefore no surprise that 0% of the firms have completed their transition programme.
What are the limitations of your existing tools/systems?
In terms of business tools and systems, it is important for firms to establish where and how processes will be impacted by the reform and then decide how these changes will be implemented. Although some changes will be simple to refine, the scale of the transition means firms must be prepared to assign significant resources and in some cases rely on third-party technology providers, like Quantifi, that have the capacity to support the transition process. Leveraging third-party technology can help firms accelerate their transition programme with confidence.
LIBOR and other benchmarks are entrenched in firms’ systems, processes, and models. From these results we can see that many firms’ existing systems are limited when it comes to much of the heavy lifting required for the transition including data consolidation, modelling, reporting, risk and profitability analytics. Since the proposed alternative rates are calculated differently, payments under contracts referencing the new rates will differ from those referencing LIBOR. The transition from LIBOR will bring considerable costs and risks for firms. It will alter firms’ market risk profiles, requiring changes to risk models, valuation tools, product design and hedging strategies.
Given the fluid state of COVID-19 and changing practices for business as usual in general creates an unexpected overhead and poses huge operational restrictions. This is particularly the case for those firms with outdated technology infrastructures that are unable to adapt to the new reality.
What are currently your TWO largest challenges in implementing RFRs?
Participants were asked to select the two largest challenges of the transition from the following list; Regulatory uncertainty (25%), Operations and technology upgrades (19%), Recalibration of models (5%), Lagging liquidity in ARR derivatives (8%), Renegotiation of existing contracts (16%), Lack of term rates (16%), Delays due to COVID impact (3%)and poor data quality (7%).
The lack of definitive regulatory guidance on the IBOR transition has put responsibility for engagement in the hands of market participants. This absence of direction has led to inaction, which in turn threatens to delay implementation for many firms. Whilst timelines have been developed, there are variations across jurisdictions. It is important for firms to ensure that internal timelines are aligned with regulatory timelines.
There is still no clear consensus in the market on how IBOR will be replaced in legacy contracts and, as such this poses one of the biggest challenges in terms of operational and computational effort involved within the transition. As the transition progresses, firms will move from exploring to implementing enterprise-wide uses of new technologies. This will change how they monitor their risk profiles and provide updates on stress test and risk forecasts. For 19% of firms, operations & technology upgrades are a major challenge. For financial institutions with outdated technology, another considerable challenge will be the time and cost involved upgrading or replacing existing operations and technology to support today’s rate regime and a future state post LIBOR. Firms need to fully evaluate their technology infrastructure, assess the level of risk for impacted areas and, then identify opportunities to migrate to new platforms or systems.
Which are the TWO most important activities for your firm in the next 12 months?
The next 12 months will be a period of major acceleration in the LIBOR transition. A disorderly transition would be detrimental to firms. It is therefore paramount that firms identify and manage delivery risks as efficiently as possible to avoid issues further at a future point.
Implement changes to impacted systems and processes (27%) and Deploy transition analytics to analyse exposures, P&L, risk (16%) were selected as the two most important activities for firms in the next 12 months. Other tasks included; Deploy operational infrastructure to automate and speed up transition tasks (15%), Accelerate communications/renegotiation with clients and counterparties (14%), Improve legal process workload associated with contracts (7%), Legal risks – assess, manage and mitigate for potential litigation (11%), Design new ARR products across all business units (3%) and Execute operational readiness testing (7%).
Financial institutions recognise the impacts to their systems and processes caused by the LIBOR transition. Many legacy systems are unable to handle ARR curves and others are relying on outdated data structures. It is crucial that firms resolve these issues ahead of the transition. These firms may consider partnering with a third party provider that can offer the models and technology expertise to deliver the necessary support.
Another key focus will be ensuring that firms have the analytics and infrastructure in place to make optimal decisions on how to transition. This will include deciding which clients to prioritise, which exposures to address and determining which hedging strategies to adopt.
When does your firm expect to complete ongoing IBOR transition efforts?
All indications suggest that that LIBOR cessation will continue as expected by the end of 2021 and the majority of firms surveyed are prepared for this (70%). Financial institutions should not wait any longer to begin implementing the alternative reference rate across all product areas. Firms that expect to complete their transition beyond March 2022 (3%) and firms without fixed timeframes (27%) may be struggling to meet the new requirements or be paralyzed by regulatory uncertainty. Financial institutions that are hesitant to move forward need to recognise that a last-minute dash for compliance will create the potential for costly errors. Inadequate preparation and mistakes in implementation will end up costing even more time and money so it is crucial that firms determine a plan of action and work to the timeframes set by the industry.
Conclusion
The IBOR transition impacts almost every part of the financial services industry including banking, capital markets, insurance and asset management. The imminent retirement of IBOR has forced financial institutions to conduct an end-to-end inventory of LIBOR exposure. This should cover the full range of processes and systems, including pricing, valuation, risk management and booking. It should also cover contracts with clients, counterparties, creditors and others. This process has revealed a number of challenges for financial markets participants, with many having to rethink their operations and technology infrastructure and adopting new technologies to help with the transition.
With less than 18 months to go until the expected LIBOR cessation, the road ahead remains challenging and unknown. It is important for market participants to put in sufficient resources and effort, as the preparatory work for the transition will be substantial and complex. In operationalising the new benchmark rates, legacy risk management and frameworks should be upgraded as using the latest technology and innovating faster will be imperative in paving the road ahead for the benchmark reform and beyond.
How Quantifi can help:
Quantifi can help clients navigate the LIBOR transition by providing support for data management and the construction and calibration for LIBOR replacement curves including ESTR and SOFR curves. Curves can be calibrated to a variety of market instruments including SOFR futures. Quantifi also supports the modelling of basis curves. An interest rate curve can be constructed as a spread over another curve. This gives clients the flexibility to model these new curves in a variety of ways. Quantifi’s scenario and what-if capabilities allow clients to analyse the impact of switching a trade from an old reference rate to a new reference rate, which can support clients in analysing legacy trades and negotiating new terms with their counterparties.