Interbank offered rates (IBOR) are set to be replaced by alternative risk-free rates (RFR) by the end of 2021. Most financial services players are currently finalising their transition plans while looking to minimise transition disruption. The reform impacts firms differently, depending on their organisational and infrastructure setup. Thus, the reform is raising uncertainties due to the complex and invasive change industry interdependency creates.
Despite their differences, firms face some common challenges around this transition, as summarised below:
- Securing alternate benchmarks: Due to the overall push to transaction-based benchmarks and the absence of unsecured benchmark rates, in some markets, unsecured lending will face new challenges in price discovery.
- Risk and hedging strategies: Because the proposed alternative rates are calculated differently, the transition will change firms’ market risk profiles. Changes to risk models, valuation tools, product design and hedging strategies will be necessary.
- Liquidity: Building liquidity for the new benchmark rates could prove to be difficult because the liquidity of the new rates (e.g. secured overnight financing rate [SOFR]) is currently being questioned, due to the lack of transactions based on the alternative rates.
- Exposure management: IBOR replacement impacts USD 370 trillion in existing contracts. This means that significant effort will be required to determine a bank’s current exposure to IBOR and agree to a transition strategy. Continued use of IBOR in new contracts extending beyond 2021 will generate a backlog of potential problems.
- Contract review: Identification of IBOR transition-impacted contracts, legacy contract renegotiations and contract reviews/fall back modifications will be challenging due to the non-standardised nature of contracts. To mitigate potential conduct, reputational and legal risks, these efforts will require a clear, consistent and justifiable transition approach for both clients and regulators.
- Regulatory guidance: Differing regulatory treatment of RFRs across jurisdictions is likely. The lack of definitive regulatory guidance on the IBOR transition may slow down progress. Industry coordination by banks is emerging but limited.
- High litigation, reputation and conduct risk: Differing regulatory treatment of RFRs across jurisdictions is likely. The lack of definitive regulatory guidance on the IBOR transition may slow down progress. Industry coordination by banks is emerging but limited.
The reform impacts the entire banking supply chain, from front office to back office operations and including regulatory and IT functions. The reform is also forcing adaptation to risk and profit and loss (P&L) computation. However, if addressed on time, the transition may also represent an unrivalled opportunity to ensure a bank’s readiness for a more flexible, nimble and collaborative world―preparing the future on the back of a mandatory adaptation.
Areas for adaptation most notably include the following:
- Data management infrastructure
- E2E operational chain process review
- Legal and client-facing policy updates
- Contractual management automation
- AI-upgraded systems
Accenture is helping industry players benefit from the reform.