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LIBOR transition – challenges and Deutsche Bank’s approach - YouTube
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LIBOR has been a cornerstone of the financial services industry for several decades
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and moving away from it presents considerable challenges.
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These include: impacts on clients.
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Clients will have to conduct a business-wide risk assessment,
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as well as reviewing and potentially renegotiating hundreds,
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maybe thousands, of contracts. Other considerations include modelling the potential
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impact on accounting,
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hedge accounting and corporate earnings,
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and potentially having to modify systems to support multiple benchmark rates.
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Pricing. IBORs tend to be priced higher than RFRs,
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because they contain both credit risk and term premiums.
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The impact on the valuation of trades must therefore be
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considered when amendments to trading terms are being agreed.
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Conflicts of interest. Transition decisions will likely have commercial impacts,
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including timing of transition, selection of successor rates,
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spread adjustments, and fallback language.
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Mis-selling and market disruption.
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There's a risk of regulatory scrutiny or client disputes,
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particularly if fallback provisions are not adequate.
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Fair pricing and choice of replacement rate. Successor rates,
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spread adjustments, and any margins must remain fair.
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Anti-trust and market abuse. There's a risk of perceived or
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actual collusion among peer firms to gain from transition.
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Variations between RFRs. Some RFRs are secured vs
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some unsecured.
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This may pose a challenge for multicurrency deals
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and cross-currency swaps.
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In addition, different publication times for each RFR could also
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add to the complexity.
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There may be insufficient liquidity in the market for RFRs.
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Term rates.
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Risk Free Rates are, by definition,
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overnight maturity, and are calculated in arrears.
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Whereas LIBOR has a forward-looking term structure, and has
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been the market standard for large volumes of loans.
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Corporates often want to know their borrowing costs in advance,
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and consumer protection in some jurisdictions sets out in law
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the requirement for customers to know their borrowing costs in
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advance. Work to design forward-looking term rates based on
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Risk Free Rates is well advanced in some jurisdictions.
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Forward-looking term versions of SONIA are now available, with
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other RFRs,
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except SARON, expected to follow.
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Legacy contracts will need to be reviewed.
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The preferred outcome from the official sector, and the bank's
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preferred strategy, is to proactively amend transactions before the expected
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LIBOR cessation dates.
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Alternatively, the pre-existing language in the contract explaining what
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happens if LIBOR becomes unavailable -
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what's known as 'fallback provisions'
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will need to be updated.
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Deutsche Bank is committed to helping clients and the industry
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adapt to the new Risk Free Rates.
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The bank's Group-level strategy is underway to address
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all aspects of the transition,
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such as developing modified products, transitioning the legacy portfolio,
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updating fallbacks,
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and enabling RFR funding. Since 2018,
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the bank has had a dedicated IBOR Transition Programme, focusing on
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updates to products and processes,
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understanding LIBOR exposures, and educating internal and external stakeholders.
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There are RFR alternatives in place of many of Deutsche
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Bank's existing LIBOR-linked products, in readiness for transition.
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For example, linear derivatives, loans and floating rate notes.
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Other products, such as trade finance,
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working capital and export finance, require knowing the rate
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in advance and have a dependency on the availability of
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forward-looking term RFRs.
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The bank has already completed a number of trades
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referencing Risk Free Rates across a range of products,
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including revolving credit facilities, swaps,
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floating-rate notes, and reverse repo agreements.
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Deutsche Bank also actively contributes to more than 60 official
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sector and trade association working groups on RFRs
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and LIBOR transition.
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To find out more, please visit www.db.com/IBORtransition
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Or search Twitter and LinkedIn for #DeutscheBankIBORtransition
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