Fund Finance Insights

LIBOR: staying ahead of the transition

5 minute read time

Mat James, RBS International’s Head of Product & Risk Management, and Graeme Shields, Programme Manager, LIBOR and Corporate Lending, discuss progress made in the UK’s transition away from the widely used benchmark interest rate and key considerations for customers as we approach the transition deadline.

Despite the disruption caused by the global pandemic over the past year, UK regulators have announced the cessation of LIBOR from 31 December 2021, with the Sterling Overnight Index Average (SONIA) risk-free reference rate already well established as its replacement. Mat James and Graeme Shields discuss progress made on the transition in 2020 and the first few months of 2021, and how RBS International is helping customers prepare for the end of LIBOR.

How would you sum up recent progress on the transition away from LIBOR?

Mat James: “Awareness and the engagement of banks, customers and regulatory bodies has ramped up considerably. This time last year, this was still a theoretical change, but there’s a lot more urgency to the messaging coming from central banks and regulators now.

“It now feels like new borrowers are comfortable with the concept, particularly following the requirement for a risk free reference rate from 01 April for new term facilities. The bigger concern is engaging with existing borrowers. New borrowing customers, lawyers and banks have had to work with the new arrangements over recent months. For existing borrowers, there is more time for the transition, although things have ramped up there, too. We are engaging with those customers to explain the options they have.

“We haven’t heard of any problems following the end of issuance of new LIBOR-linked products in March 2021. That’s the result of work by banks and their customers, and clear messaging from regulators, which has been very helpful.”

What have been the guiding principles behind the approach RBS International has taken to support customers through the transition?

Graeme Shields: “Our customer facing staff have been upskilled, so they can have informed conversations with customers. We cannot provide advice, but we are providing information to allow customers to make informed decisions. Treating our customers fairly is the most important thing, making sure they’re not disadvantaged by anything that we’re doing. The NatWest Group and RBS International have worked closely with regulators and are at the forefront of this transition.”

What are the most important remaining problems to overcome before the end of 2021?

Graeme Shields: “We’ve got strong customer engagement, but with the pandemic happening, customers have had other needs to address. We will continue to educate customers that SONIA is here to replace LIBOR for the existing loan facilities.”

Mat James: “The biggest issue would be cliff risk, if everybody leaves engagement on transition until the last minute. As an industry we need to work with our customers to avoid this taking place, by addressing concerns as soon as we can and ensuring resource is available to assist customers in making informed decisions.”

SONIA is an overnight rate, whereas LIBOR was fixed in advance for a set period. With that in mind, a forward-looking version of SONIA might be needed in some circumstances, so Term SONIA reference rates are being developed. What is your assessment of the effectiveness of Term SONIA reference rates as developed to date?

Mat James: “From my point of view, creating a term rate, taking a view on where SONIA will move over the coming period, theoretically removes some of the risk-free elements. But it means customers will have an important choice. If a customer wants certainty over cash flows from quarter to quarter, that’s where the demand for a term rate will come from. Alternatively if the customer is looking for the assurance of a risk free rate, weighted average SONIA will provide that. ”

“Treating our customers fairly is the most important thing, making sure they’re not disadvantaged by anything that we’re doing. The NatWest Group and RBS International have worked closely with regulators and are at the forefront of this transition.”

Graeme Shields, programme manager, LIBOR and corporate lending, RBS International

Graeme Shields: “RBS International is in a good place because we’ve invested in technology platforms for lending products that allow us to move with the market. We’ve got the flexibility to do what’s right for the market.”

The International Swaps and Derivatives Association (ISDA) has calculated fallbacks designed to manage risks related to the structural differences between IBORs and risk-free reference rates. The fallbacks are adjustments to SONIA that act as a safety net for financial products that reference LIBOR after December 2021, or in a ‘pre-cessation event’ where a regulator decides, prior to December 2021, that LIBOR no longer represents financial reality. How effective has the industry’s work on fallbacks been?

Mat James: “Fallbacks are well understood by the industry and the banks, but probably less well understood by the customer. New borrowers understand what their interest rate is from a risk-free reference rate perspective as a result of the changes in April 2021. We don’t have that for our existing borrowing community, so it’s probably less well understood when you look at loans and loan-linked derivatives. As with the transition generally, having conversations with your relationship banks sooner rather than later will enable borrowers to make informed choices.”

On which milestones within the transition process should banks, fund managers, asset managers and other affected market participants be focused at present?

Mat James: “For existing borrowers, December 31 is the one date to focus on. In the UK and Channel Islands, we are hopefully coming through the worst of the pandemic and expecting some form of return to normality particularly with vaccinations being rolled out. With the prospect of international travel beginning again, there may be distractions over the course of the summer, either from work or holiday. Equally business activity could increase as the year progresses, putting increased time pressure on transition considerations. Waiting to engage in Q4 could undermine what we’ve been doing. It’s in everyone’s interests to take this transition seriously and not leave it to be an H2 issue.

“There are different options in terms of what you can do to prepare, and some of those decisions will require board approval, so one question is: how do you fit a December deadline into your corporate governance structure? That could mean beginning engagement fairly soon.”

Graeme Shields: “By the end of May, we would have expected to have spoken to 90% of our customer base. We will have provided them with relevant information and documentation to consider, and we would encourage them to review in a timely manner to avoid a last-minute rush.”

Are you confident that most market participants and all necessary financial and operational infrastructures will be fully prepared for the transition deadline in December 2021?

Mat James: “In theory, yes. But as this is not a global exercise but a Sterling-led approach, and as our customers operate across numerous jurisdictions there will be more difficulties to overcome. But I am confident that banks and borrowers will not have a systemic issue on the back of this.

“Early engagement is the key: that allows the banks to look at what infrastructures are in place to allow that transition. This is not something the banks can do unilaterally; this is a customer-driven change for existing borrowers. So customers need to engage with us and all their finance partners to ensure a safe transition.”

By David Adams