Libor replacements are untested in a hiking cycle
Interest rate uncertainty may not have added to the complexity of the transition away from Libor pricing, but it has implications for forecasting that will only become clear as rate rises kick in.
Uncertainty around how the secured overnight financing rate (Sofr) will react to interest rate hikes raises the possibility of near-term pricing anomalies and inconsistencies in the commercial loan market, according to Greenwich’s latest commercial lending market insight report.
Nevertheless, Stephen Farrell, audit & assurance partner at Deloitte, says that uncertainty around interest rate rises has not tended to come up as a key consideration on Libor transition between banks and customers.
“Perceived or actual uncertainty over the availability of a Libor rate for the issuance of new products tends be to a greater consideration, notably for corporate customers who perhaps haven’t considered in full how unavailability would impact their interest rate management,” he explains.
Another challenge Deloitte has observed is the ability to forecast interest payments due to the backward-looking nature of risk-free rates. If someone took out a loan on six-month GBP Libor beginning December 2021, they would already know how much interest would be due in May 2022, explains Svenja Schumacher, the firm’s assistant director financial advisory.
“A loan on Sonia [Sterling Overnight Index Average], in comparison, would have already captured the two interest rate hikes from December and February through higher daily rates, which are compounded to make up the final rate,” she says.