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12 November 2020

Benchmark reform preparations should continue despite Covid-19 disruptions

 In recent years, financial benchmarks have been under much scrutiny and reforms are underway for some of these benchmarks in order to align them with industry principles. 

Interest rate benchmarks, including the London Interbank Offered Rate (LIBOR), are used to price financial contracts such as loans, interest rate derivatives and bonds worth more than $350 trillion, according to some estimates. LIBOR is essentially aimed at reflecting the rate at which major banks can obtain unsecured funding in a specific currency and for a specific term in the London interbank market.

However, the LIBOR benchmark, which has been the main reference rate for adjustable-rate financial products for more than three decades, is set to be retired by the end of 2021 as regulators move to bolster the stability of the financial system. This is because concerns have been raised about the integrity of interbank offered rates (IBORs) in general since they are susceptible to manipulation and have seen declining liquidity.

While some intermediate milestones have shifted, regulators still plan to move away from LIBOR by the end of next year despite the upheavals caused by the pandemic, and much progress has been made in the development of alternative ‘risk-free’ rates. This means that financial services firms, corporates and other market participants need to push ahead with their preparations for the transition to the new reference rates.

The global Financial Stability Board (FSB) confirmed in July that companies should still work towards transitioning away from LIBOR before the end of 2021. In fact, the FSB said that Covid-19 has shown that the underlying markets LIBOR seeks to measure are no longer sufficiently active.

In August, the Bank of England started publishing the Sterling Overnight Index Average (SONIA) Compounded Index to support the transition in sterling markets. 

In addition, the International Swaps and Derivatives Association (ISDA) recently published a standardised ‘fallback’ protocol for the derivatives industry, effective from 25 January 2021. 

Term versions of LIBOR-replacement rates are also in development – these will be backward-looking rates, whereas LIBOR is forward-looking. 

While there is still a level of uncertainty about how interest rates will be calculated under the new benchmarks, all organisations with exposure to LIBOR need to be making progress in their transition plans. This requires collaboration aimed at transitioning loans and other financial products that reference LIBOR, into ones that reference suitable alternative reference rates.

To minimise disruptions, organisations with LIBOR-referencing contracts should assess the impact of the transition on their businesses – including on IT systems and legal contracts, as well as identifying the risks – and take proactive measures to mitigate the risks.

To ensure the shift is as smooth as possible, Standard Bank has established a dedicated project office to coordinate the group’s transition efforts and to put measures in place to assist clients, providing tailored transition solutions for clients which will differ by the type of product involved. Where clients are affected by the discontinuation of LIBOR, they will need to review the fallback language regarding the benchmark’s cessation and identify risk-mitigating actions, such as renegotiating those contracts.

With effective planning and risk-mitigation strategies in place, organisations will be able to ensure they experience minimal disruptions as global financial markets adopt new interest rate benchmarks before the cessation date at the end of 2021.

Click here for more information on the discontinuation of LIBOR.