Rate reform is coming. Are financial services firms ready?

The London Interbank Offered Rate (LIBOR) serves as the benchmark reference rate for a wide range of wholesale and retail financial products, and for decades it has served as one of the most important benchmarks in the financial industry. But a series of scandals regarding IBOR manipulations has prompted financial regulatory authorities to replace LIBOR with the Alternate Reference Rates (ARRs) by 2021.

Although estimates vary, it is generally accepted that financial products with a notional value in excess of $350 trillion globally are currently tied to IBOR rates. The swap will have a major impact on financial services firms around the world, and countries are lining up behind their chosen alternative rates. The United States has selected the Secured Overnight Financing Rate (SOFR), the United Kingdom will use the Reformed Sterling Overnight Index Average (SONIA), Japan will use the Tokyo Overnight Average Rate (TONIA).

The sheer multiplicity of IBOR-referencing products, stretching from OTC derivatives through syndicated loan portfolios to retail mortgages and automotive loans, means that most financial services organisations will be faced with complex and far-reaching technology change requirements over an extended period of IBOR Transition.

Let’s examine the main areas IBOR Transition will impact across financial services technology estates and consider some of the key system changes that IT change teams will need to frame and deliver to support the successful adoption of ARRs.

System Impact Analysis

IBOR transition will eventually touch almost every aspect of front-to-back financial services technology system flows. However, despite these almost overwhelming change implications, there are five key areas where the system and architecture impact will be greatest:

  • Data Management – The inception of new ARRs creates a series of challenges for data sourcing and validations, including market data feeds, broker screens / vendor data for new products, as well as data sets to support complex multi-curve construction.
  • Primary Trading Systems – There will be a variety of configuration changes and re-tooling requirements for Sales & Trading platforms that are used to price, capture and execute trades on ARR-referencing products.
  • Risk Management – Wide-ranging system changes will be required reflect changes to product valuation and risk management models. In addition, historical data sets for key risk model conventions will need to be accrued and added to libraries over time.
  • Post-Trade Processing –Back-office platforms will need to support the booking, processing and valuation of ARR-referencing products, as well as accommodating the bulk novation of contracts and trade documentation that reference legacy IBOR products.
  • Treasury & Asset Liability (ALM) Management Systems – Adapting Treasury management platforms to accommodate ARR-referencing products will enable key ALM processes, including balance sheet funding, hedge accounting and cash-flow forecasting.

Focus Area – Front Office Reconfiguration

Technology teams that support Sales & Trading platforms are bracing themselves for broad portfolios system reconfiguration and re-tooling requirements.

The central role that Primary Trading Systems (PTS) now play in the management of front-to-back trade flows for IBOR-referencing products means that these transition requirements will extend well beyond just pricing and deal capture functionality.

The breadth of potential IBOR transition requirements in the front office domain is summarised in the following diagram:

potential IBOR transition requirements

In addition to framing and prioritising portfolios of system reconfiguration and re-tooling changes, I anticipate that front office changes teams are likely to be involved in the following activities:

  • Constructing accurateinventories of impacted trade populations across products, trading desks, lines of business, geographies
  • Defining conversion approaches across products and asset classes – complex products (for example, swaptions) will be managed as ‘exceptions’ to ‘vanilla’ conversion approaches
  • Unwinding or terminating and potentially rebooking open trades that reference legacy benchmark rates
  • Negotiating (potentially with third party arbitration) new ARR-referenced spreads for rebooked deals
  • Creating new products that reference new benchmark rates across currencies

Starting the LIBOR Transition Journey

Investment banks with Rates and Fixed Income trading businesses will be most obviously impacted by IBOR transition, but the impact will extend to any financial services organisation that uses IBOR-referenced benchmarks to value its product portfolios.

Despite their size, larger financial organisations, with more mature change delivery capabilities are best placed to meet the IBOR transition. Many smaller organisations, perhaps lacking experience in complex programme delivery will feel the burden of IBOR transition more acutely.

However, despite these challenges there are series of practical steps that multi-disciplinary change teams can take now to prepare their organisations for the impending LIBOR Transition journey:

  • Perform a ‘scan’ across businesses to assess likely transition challenges and key impacts across front-to-back processes and system flows
  • Determine how to amend legacy contracts to reflect ARRs, including hedge accounting treatment
  • Create inventories of legacy benchmark usage across products, calibrate exposures linked to legacy benchmark products
  • Ensure robust written contingency plans are in place in the event that a legacy IBOR rate materially changes or ceases
  • Develop a phased transition ‘playbook’ so that a transition programme can be mobilised and executed efficiently

Launching a coordinated approach to LIBOR Transition planning and analysis now will enable Financial Services firms to take the initiative on this complex and multi-dimensional marketplace challenge.

Chris-Beer-headshotChris Beer is EMEA Regulatory Practice Head for Luxoft, a DXC Technology Company. A senior change-management professional with 25 years’ financial services experience, Chris is extremely well-versed in business transformation, he has a deep understanding of a wide range of financial services businesses, including Capital Markets and Investment Banking, Global Custody, Securities Services, Wealth Management, and Retail Banking. He has intimate knowledge of managing initiatives driven by regulatory requirements, revenue growth, cost reduction, capacity and scalability, legal entity restructuring and organizational redesign.

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