Banks, firms work on strategy for transition from LIBOR to new benchmark

Will be simple for loans, tricky for derivatives, say experts

With the London Interbank Offered Rate (LIBOR) getting discontinued in 2021, about $350 trillion of linked loans and derivatives segment are now to be linked to a new benchmark.
 
There is a near consensus that the LIBOR will be replaced by the Secured Overnight Financing Rate (SOFR) for all dollar loans, but other benchmarks, too, are in the race.  Besides, India has its own benchmarks and the Indian Banks' Association (IBA) is working on a roadmap to guide banks and financial assets to get into those.
 
Senior bankers said lenders are working on two aspects regarding the replacement of the LIBOR. They are now working on a strategy for the transition to a new benchmark as this has implications for risk management, product development, and information technology, which impacts the internal systems and client businesses. Second, banks under the aegis of Indian Banks’ Association (IBA) may also approach the Reserve Bank of India (RBI) for regulatory guidances for an orderly transition.

 

The RBI, on its part, had asked Financial Benchmarks India  (FBIL)  to change its methodology on benchmark creation. FBIL has its own Overnight Mumbai Interbank Outright Rate (MIBOR)  and Mumbai Interbank Forward Outright Rate (MIFOR) -- which is linked to the LIBOR -- as financial benchmarks.
 
But final changes to these can be made only after it is established how the world shifts to a new benchmark.
 
There are several benchmarks, depending on the country of origin and currency used, which are competing for the space after the LIBOR is phased out. The SONIA (Reformed Sterling Overnight Index Average), the ESTR (Euro Short-Term Rate), the SARON (Swiss Average Rate Overnight), and the TONA (Tokyo Overnight Average Rate) are among the potential alternatives.

 
The LIBOR is fixed by a polling method where banks relay their rates to the Intercontinental Exchange, which puts out the benchmark. But after the 2012 LIBOR fixing scandal where it was found that some banks could be manipulating their rates in the poll, it was decided that the next benchmark would be based on actual trades.
 
India’s benchmarks also consider trades.
 
However, with the world moving to a new benchmark, the Indian banks and companies are awaiting clarity on how their contracted exposure will change. India’s external debt at end June 2019 was $557.4 billion.
 

Experts, on the other hand, say there is nothing to worry. “It is such a big problem that the solution has to be very simple,” said Samir Lodha, managing director at QuantArt Markets. One effective solution could be to simply tell that effective from the end of a particular period, the contract gets linked to the new benchmark.
 
“The difference won’t be more than 5-10 basis points for the loans. But for derivatives products, the modelling, software, etc, will have to be changed,” said Lodha.
 
Similarly, according to Prabal Banerjee, group finance director at Bajaj Group, the transition shouldn’t be a problem for Indian companies and banks. “The contracts will automatically get converted. The benchmarks are technically highly developed. So switching on to the new benchmark will be smooth,” Banerjee said.