Treasuries must move quickly on Libor changes, analysts say
The global race for alternative benchmarks to the much-maligned Libor is intensifying but much more work on due diligence and counterparty risk needs to be conducted.
With only weeks to go before the start of the withdrawal of numerous global Libor benchmarks, corporate treasurers might be falling behind on preparations for a switch over to alternatives, analysts say.
A review published in September by Martin Wheatley, the UK FSA’s head of conduct, recommended that Libor, which underpins approximately $350 trillion in derivatives alone, should be corroborated as far as possible with transaction data. To improve that process, the number of currencies and maturities for which submissions are made should be cut substantially, he said.
Corporations use the Libor benchmark for a broad variety of purposes, ranging from loans and derivatives, to valuations for risk-management purposes, internal transfer pricing, performance benchmarking and cash discounting. After the withdrawal of the global benchmarks, companies must decide on which new reference rate they will use.
“For companies with international subsidiaries, the withdrawal of these benchmarks is going to represent a significant challenge,” says Bob Lyddon, managing director at Lyddon Consulting. “Treasuries need to do a substantial amount of work in drawing up inventories of contracts and identifying which reference rate will need to change, and the time scales are very short.”
The Wheatley review was commissioned after a scandal erupted in June 2012 when multiple criminal settlements by Barclays revealed substantial fraud and collusion by members of the British Bankers’ Association (BBA) in submissions for setting daily Libor rates.
Among the changes being phased in during the coming weeks, the New Zealand dollar, Australian dollar, Canadian dollar, Danish krone, and Swedish krona fixings will be removed. The Swiss franc, euro, sterling, yen and US dollar fixings will be slimmed down to the most liquid maturities. Those comprise the overnight/spot, one-week, one-month, two-month, three-month, six-month and 12-month tenors.
In a consultation late last year, the BBA asked banks and corporate treasurers their opinions on the future of the fixings. While the majority agreed that the global fixings could be discontinued, a substantial minority opposed the changes, with, for example, 29% of respondents saying the Canadian fixing should be retained.
In addition, more than a quarter of respondents said the proposed end-of-March deadline for the changes was too tight, and requested more time to make the necessary adjustments. The BBA accepted those concerns and pushed out implementation of the changes, with New Zealand now set to be removed at the end of February, Denmark and Sweden in March and the Australian dollar and New Zealand dollar rates extinguished at the end of May.
The breathing space afforded by the BBA has been widely welcomed but still leaves corporate treasurers with much work to do in the coming weeks, not least to identify alternative benchmarks for their international contracts.
The BBA has declined to endorse specific benchmarks, but the Association of Corporate Treasurers (ACT) has provided a list of what is sees as the most practical alternatives.
“For use by non-financial corporates, the reference rates need to have a reliable relationship with sovereign rates and the relative credit standing of representative high-quality banks, and also to reflect market liquidity issues appropriately,” the ACT says in a note published on its website.
“Hence pure central bank rates are inappropriate, as are security-backed financial rates, [for example] repos. Similarly, overnight indexed swap (OIS) rates are unsuitable ... [because] the fixed rate of OIS is typically an interest rate considered less risky than Libor because it is influenced by the central bank rate and has less counterparty risk.”
Without backing specific alternatives, the ACT notes that in Australia the bank bill interest rate, published daily by the Australian Financial Markets Association, is treated as the wholesale interbank rate within Australia and is the borrowing rate among Australia’s top market makers.
The Canadian dollar offered rate is the recognized benchmark index for bankers’ acceptances, with maturities up to one year in Canada, it says.
In Denmark, Sweden and New Zealand, it describes the Copenhagen interbank offered rate, the Stockholm interbank offered rate and the NZ bank bill reference rate respectively.
“There are pros and cons of using these alternatives,” says Michelle Price, an associate policy and technical director at the ACT. “One of the most interesting things for treasurers may be the pricing of inter-company loans or a derivative where you price on one side at Libor and on the other side against the local benchmark. In that case, you may get a valuation that is very different.
“Also, operationally you need to decide what the most relevant benchmark for you is, and to make sure you do the due diligence first.”
As UK regulators move toward a conclusion of the Libor review process, authorities elsewhere in Europe are just at the beginning of theirs, suggesting due diligence on short-term rates is set to become par for the course.