CFOs Urged Not to Delay LIBOR Transition Plans

Procrastinating on the LIBOR transition could have serious consequences. Tom Wipf, Vice Chairman of Morgan Stanley Institutional Securities and Chairman of the Alternative Reference Rates Committee (ARRC), said: "The risk of complacency is high and will only get higher." The ARRC is a group convened by the Federal Reserve to manage the process of moving the United States away from LIBOR.

Wipf told CFO Dive that procrastination could lead to companies being left out when it comes to having necessary conversations with clients and counterparties about LIBOR.

Wipf noted that procrastination could lead to increased uncertainty in contract documentation, valuation disputes, confusion in communications with clients, and potential litigation risks.

LIBOR's Origins and Replacement

The British Bankers' Association created LIBOR in 1986 as a benchmark for floating-rate notes. However, Erin Arvedlund, author of "The Smartest Guys in the Room: The Global Banking Conspiracy That Swindled Investors Out of Billions," said that because LIBOR was based on estimates of fictitious interbank lending rates and was manipulated to boost bank profits, its problems were exposed during the 2008 financial crisis.

Although there are various reference rates, the ARRC has chosen the Secured Overnight Financing Rate (SOFR) as the primary replacement for U.S. dollar LIBOR because SOFR is based on a broad measure of overnight borrowing cash—namely, actual transactions in the U.S. Treasury repurchase market—and was created by the Federal Reserve Bank of New York.

New York Fed President John Williams has expressed support for this. Currently, approximately $250 trillion in contracts reference LIBOR, while $1.2 trillion in contracts reference SOFR.

The ARRC's Actions

The ARRC, convened by the Federal Reserve and the Federal Reserve Bank of New York in 2014, has evolved from selecting the preferred alternative rate for U.S. dollar LIBOR (namely SOFR) to developing a framework for transition plans and providing tools to make the market transition as smooth as possible.

The committee is composed of a broad range of private market participants, including banks (such as JPMorgan Chase and PNC), asset management firms (such as PIMCO), insurance companies (such as MetLife), industry trade associations (such as the American Bankers Association and the International Swaps and Derivatives Association), and exchanges (such as ICE and CME).

Additionally, trade associations such as the International Swaps and Derivatives Association and the American Bankers Association are also represented.

ARRC Chairman Wipf said that the primary task for CFOs now is to take stock of their company's counterparties and clients, assess the company's LIBOR exposure, and study viable remediation measures.

He warned: "Some remediation measures cannot be implemented."

Take Wipf, Vice Chairman of Morgan Stanley, as an example: a company might have issued a floating-rate note referencing LIBOR in 2015 with a maturity date after 2021. He said: "Without the consent of 100% of bondholders, the reference rate cannot be changed, which is nearly impossible to achieve, and the contract does not allow for amendments."

He pointed out that one reason the transition workload is so enormous is that very few contracts before 2017 mentioned the LIBOR transition.

Future Risks

Paul Forrester, a partner at Mayer Brown and one of the leading derivatives lawyers in the United States, said that the real risk for financial institutions "dropping the ball" in the LIBOR transition is the inability to agree on who owes whom and how much.

Forrester said: "The most concerning thing is the potential for a massive litigation free-for-all in courts across the United States and around the world."

Forrester noted that companies that mishandle the transition could face reputational damage and a decline in stock price. Investors might think: "If you can't manage your own business, why should I invest in you?" he asked rhetorically.

He added that a failed transition could also damage relationships with clients and counterparties.

As the transition approaches, buyers are increasingly concerned about purchasing investments without fallback provisions.

Ann Battle, Head of Benchmark Reform at ISDA, said that CFOs should be prepared to adhere to the IBOR (Interbank Offered Rate) fallback protocol when it is launched, and should work to understand what impact the fallback rate, if triggered and applied, would have on existing derivatives trades.

The protocol is intended to be the most effective way for most non-cleared derivatives market participants to mitigate risks associated with the cessation of key IBORs.

ISDA calls it a key part of addressing firm-specific and systemic risks associated with the anticipated cessation or non-representativeness of LIBOR and other quoted rates.

From an operational perspective, CFOs should understand that while the "payment date" will not change after the fallback mechanism is implemented, the "observation date" for the fallback rate will shift to the end of the relevant period (as opposed to the beginning-of-period observation for IBOR).

Battle added that CFOs should also analyze fallback provisions applicable to cash instruments hedged by derivatives. "It is important to understand that the future of LIBOR depends on whether the panel banks continue to submit quotes, rather than on traditional regulatory or legislative timelines."

Battle said that ISDA hopes to launch the fallback protocol within two to four weeks after receiving a business review letter from the U.S. Department of Justice and similar recognitions from other relevant competition authorities in other countries.

She said: "We cannot predict the timing of these processes," adding that she does not expect any deadlines to change.