A Libor-less world
Will Libor survive 2021?
Manipulations and scandals raised questions about Libor’s robustness in 2012, which led to the search for its alternative. Now, transitioning away from Libor in a haste may invite some new and unpleasant challenges for the future.
Banks around the world, were already under pressure and thought 2021 deadline was too ambitious.
2020 was supposed to be an important year for this transition. However, with Covid throwing new challenges every day, I am not sure how many banks would still have deployed those large number of staffs who were working on this transition.
Covid has forced most of the employees to work remotely. Banks do have a contingency plan, but this is not a flood or a power outage situation. This is much bigger and has already created a lot of new real-life worst-case trading scenarios.
Effects of Covid can be long-lasting and devastating, both of which is impossible to estimate at the moment. In the current economic instability, there will be more voices raised against alternatives like SONIA and SOFR (backward looking rate) to replace Libor(forward looking rate). By design, backward-looking term rates do not reflect expectations about future interest rates and market conditions. This will make the evaluation more difficult.
Furthermore, new Libor-linked instruments are still being created and sold. The benchmark still serves as a reference rate for over 300 trillion dollars in financial instruments. More than a third of these contracts do not specify an alternative. What will happen when Libor will cease to exist? Fine prints of this transition plan and the fallback language will just add more complications (and risk).
The transition is already exposed to Market risk, operational risk, ALM risk, credit risk, legal risk and liquidity risk. To me, the risks of this transition look much bigger than the transition itself.
The regulators are still insisting on the deadline and Libor-less world will be a reality for sure. I just hope the risks are respected and the banks are given comfortable time to prepare well for the move.
*multiple sources. Views are personal.
Lead Investment Risks and Multi Credit Inv Strategy India
4 年Hey Sushant wrt LIBOR the banks and clients are way ahead in terms of negotiations which is where your ISDA fallback comes into play. There have been on and off discussions of delaying it by an year but regulators are still going to play hardball. Wrt term structure it’s exactly the same way the LIBOR is being dealt with.