This article was updated on March 30, 2020.
Editor's note: Oliver Wyman is monitoring the COVID events in real time and we have compiled resources to help our clients and the industries they serve. Please continue to monitor the Oliver Wyman Coronavirus hub for updates.
Market participants have been preparing for the permanent discontinuation of LIBOR, which industry regulators have indicated could be as early as the end of next year. This is a massive task impacting the entire financial services industry with, according to Oliver Wyman estimates, costs to the industry well over $5 billion dollars.
But that was before COVID-19. So, if you’re involved with LIBOR—like the two of us and thousands of others are—how should the market and your firm react now?
To summarize: one of the lessons of the 2008 global financial crisis is that firms which manage to continue projects and programs through the tough periods can jump ahead of peers who simply “stop.” This is also likely to be true for LIBOR transition.
Let’s acknowledge that the pandemic’s severity is not yet known. While we all hope the outcome is contained and minor, it is hard to plan on that.
Our hypothesis is that many industry programs may be curtailed near term, given the seriousness of COVID-19. COVID-19 will require firms to focus on maintaining business continuity and supporting resiliency. Firms will prioritize the “human and people” challenges, focus on customer support, keeping essential operations working, and contingency planning. At the same time firms will be under economic pressure, so we expect there will be cost cutting at some point. As a result, change programs such as LIBOR, will be in the crosshairs and all but the most critical are likely to be slowed or postponed.
So how does this affect LIBOR transition? This change has serious regulatory timelines, whichwere just reaffirmed on March 25, 2020 by the UK Financial Conduct Authority (FCA). While LIBOR transition is a major program, it is not based on an immovable date like Y2K. The expected discontinuation date of LIBOR is the end of 2021, a “human defined” date, and not hard-coded. For example, regulators can ask banks to keep submitting the rates that make up LIBOR, and the banks can agree. To date more than a dozen firms have asked us “will LIBOR transition timing be pushed back?” Oliver Wyman has no inside information on this, but we do have some thoughts.
Although regulators have indicated that the industry should stick to the 2021 date, it does seem possible that LIBOR transition may end up being extended by 1 or 2 years. The natural inclination of many will be to freeze their programs and restart at a later time. In our view, that would be a terrible mistake. LIBOR is still a fragile rate, unsecured interbank lending is unlikely to increase in volume, and regulators will still want the industry to be prepared for LIBOR’s end.
But if there is a delay, the market and firms can use that time to their advantage. Specifically, to:
First, continue Alternative Reference Rate (ARR) market development.
For example, the US dollar (US$) alternative, the Secured Overnight Financing Rate (SOFR), only began publishing in April 2018. Today, the market badly needs additional liquidity. Plans for this year to build liquidity include moving the central clearing counterparty (CCP) discounting to SOFR, increasing issuance of SOFR floating rate notes (led by the Federal Home Loan Bank System), and moving the conforming mortgage market to SOFR. These are all constructive for the SOFR market and should continue. The SOFR market needs liquidity, and time to develop that liquidity. Similar efforts should be prioritized for other ARRs.
Second, progress on new fallbacks.
The International Swaps and Derivatives Association (ISDA) protocol for derivatives should be made as these are a major market procedural overhang.
Third, finalize the use for SOFR in lending—or not.
A number of US banks have indicated their preference to use another alternate for LIBOR as the base rate for loans, but actually working through that choice and seeing if there is a viable International Organization of Securities Commissions (IOSCO) compliant rate is still a significant body of work. Any delay should be used to understand the need for another rate option, validate it against recent market experience, and evolve thinking.
Fourth, firms should use any extension wisely.
Many firms are finding LIBOR transition to be difficult and many could use more time. There are two standout activities:
- Managing LIBOR fallbacks, and
- Upgrading systems to support the new rates, which work differently. Firms should use any extension to continue and complete these efforts, all of which will derisk the transition when it occurs.
For fallbacks, firms should finish capturing information that is in paper form, and institute new fallback language supportive of the transition (such as ARRC recommended fallbacks) for new transactions.
For the systems work, firms have been struggling to upgrade systems to process the new Alternative Reference Rates and this work should continue to be prioritized. Any timeline extension allows firms to “catch up” to their critical processing needs for both internal and vendor systems.
Firms will prioritize the “human and people” challenges, focus on customer support, keeping essential operations working, and contingency planning. As a result, change programs such as LIBOR, will be in the cross hairs and all but the most critical are likely to be slowed or postponed.
Finally, inventory and organize work so it can restart.
Even if the LIBOR transition date is extended, it will happen; in the words of the Federal Reserve Bank of New York President and CEO John Williams, “Some say only two things in life are guaranteed: death and taxes. But I say there are actually three: death, taxes, and the end of LIBOR.”
Most firms’ LIBOR transition programs already have substantial work underway. If there is an extension of the transition timeline, it will be invaluable to have this work organized and archived so as to support a quick restart when the program needs to be completed. We do not believe there are any scenarios where LIBOR will not end.
To summarize; one of the lessons of the 2008 global financial crisis is that firms which manage to continue projects and programs through the tough periods can jump ahead of peers who simply “stop.” This is also likely to be true for LIBOR transition.