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Blog > September 2020 > How Financial Services Companies Can Tackle the LIBOR Transition

How Financial Services Companies Can Tackle the LIBOR Transition

Financial services organizations are facing another wave of regulatory pressure. They have been tasked with transitioning away from the London Interbank Offered Rate (LIBOR) to alternative overnight risk-free rates (RFRs) by December 21, 2021. This task, similar to other recent regulations like the GDPR and CCPA, is necessary for financial services companies to continue serving their customers and to reduce risk – but it’s not easy.

For companies just starting the transition, here are the top challenges related to LIBOR and how to solve them.

What is LIBOR and Why Must Banks Transition?

LIBOR is a rate at which a selection of banks on the London money market are prepared to lend to one another – and it’s deeply rooted in the market. LIBOR underpins contracts affecting banks, asset managers, insurers and corporations estimated at $300 trillion globally on a gross notional basis. This reliance was a main cause for the LIBOR Scandal in 2012, where bankers reported false interest rates to manipulate the markets and boost their own profits. In response, policymakers and regulators determined the rate must be replaced because it is prone to manipulation.

Why is the LIBOR Transition Challenging?

LIBOR is so embedded in the day-to-day activities of financial services providers and users that even identifying a company’s exposures to it is A) highly complex and B) risky. The rate touches on every part of financial services companies – from legal, to risk, to valuation, to tax, to accounting. Organizations must identify the connections between the different infrastructure systems and transition every application associated with LIBOR from end to end.

For example, challenges could arise when one business unit starts to renegotiate a loan contract and looks to amend its provisions beyond just changing the reference rate (e.g., following a customer request and/or commercial opportunity). This action could compromise the accounting treatment, because the contractual change could be deemed a substantial modification. Separately, large-scale operational and IT impacts must be factored into the overall transition plan, recognizing that there will be linkages between this work and other major IT and operational projects.

Understanding the scope of this transition, there is a major challenge companies face: they lack the visibility needed to identify LIBOR usage in their systems, processes, data stores and applications. From corporate treasuries to data lakes, most organizations will need to manually open a huge volume of applications and dissect thousands of data sets to discover LIBOR – ensuring that not one system or process was missed. The transition could take months, if not years. This pace is far too slow to meet the 2021 deadline.

What Unique Data Management Challenges Should You Consider?

The data management challenge is colossal. Over 100 million transactions reference the LIBOR and must be replaced with alternative risk-free rates (“RFRs”), such as SOFR for the U.S. dollar and SONIA in the UK.  Making the switch won’t be a simple search-and-replace exercise. Here’s why:

  • RFRs are overnight rates, whereas LIBOR is published for multiple terms (e.g., one-week, three-month, etc.).
  • Credit risks are embedded in LIBOR, while RFRs are “risk-free,” making a simple conversion impossible.
  • RFRs have different behavioral characteristics than LIBOR, resulting in different historical spreads, so fallback rates must be applied.

To make the transformation, contracts referencing the LIBOR will all need to be rewritten.  Must locate all references to LIBOR in contracts they hold to update with fallback provisions reflecting the new RFR terms and communicate the new terms to clients.

While some banks have made a start on contract remediation, the data impact is even broader.  Firms will need, for example, to create new models for pricing using the new benchmarks, creating new credit risk spreads, and evaluating how that will affect margins and profitability – and far fewer firms have yet reached that point. Firms will also need to consider the impact of these new benchmarks on their FRTB and BCBS 239 programs.

What Tools Can Companies Use to Solve this Challenge?

ASG’s Data Intelligence (ASG DI) portfolio helps leaders build a foundation for trust in their data by building an inventory of LIBOR-related data. If organizations begin their transition without an inventory, they can’t ensure that every LIBOR-related data element is being identified within the organization – at an enterprise- and LOB-level.

ASG DI provides automated data inventory and data lineage capabilities, which help financial services organizations understand where their information comes from, how systems processed it and how it’s been used. With the ability to trace data from its origin to target, organizations can see exactly which applications have been impacted by LIBOR. From there, they can contextualize the data by connecting the dots – both in a horizontal manner (connecting data fields by identifying transformations) and a vertical manner (providing meaning from a technology-to-business standpoint). In doing so, organizations can link LIBOR to different physical implementations.

This process will enable companies to govern and share LIBOR-related data using a comprehensive metadata management repository, business glossary and data lineage support. Benefits will include:

  • Fast time-to-value through automation of data discovery/inventory  
  • Improved trust in data and its use in decision-making, strengthening a data-driven culture 
  • Mitigation of transition-related risks 
  • Cost reduction in LIBOR transition support 
  • Increased productivity through automation of impact analysis

The LIBOR transition may be quite the undertaking, but with the right data intelligence tool, organizations can automate the most complex, time-consuming aspects of it. Even more important, they can lay a foundation for trust that will improve data management and help them to be more agile in the future – especially as the regulatory landscape continues to evolve.

To learn more about how ASG Data Intelligence can help financial services organizations tackle the LIBOR transition, watch this webinar, “LIBOR Replacement: Meeting Challenge in a Process and Technically Efficient Way.” You can also check out the ASG DI product page here.

Posted: 9/15/2020 8:30:00 AM by Jeanne Lack
Filed under :Data, Information, Intelligence, LIBOR, Management