The London Interbank Offered Rate (LIBOR) serves as the benchmark reference rate for a wide range of wholesale and retail financial products. Although estimates vary, it is generally accepted that financial products with a notional value in excess of $350 USD trillion globally are currently tied to ‘IBOR’ rates (including EURIBOR and TIBOR).
The sheer multiplicity of IBOR-referencing products, stretching from OTC derivatives through syndicated loan portfolios to retail mortgages and automotive loans, means that most Financial Services organisations will be faced with complex and far-reaching technology change requirements over an extended period of IBOR Transition.
In this paper, I look at the main areas of IBOR Transition impact across FS technology estates and consider some of the key system changes that IT change teams will need to frame and deliver to support the successful adoption of Alternative Reference Rates (ARRs).
System Impact Analysis
IBOR transition will eventually touch almost every aspect of front-to-back Financial Services technology system flows. However, despite these almost overwhelming change implications, there are five key areas where the system and architecture impact will be greatest:
- Data Management – the inception of new Alternative Reference Rates (ARRs) creates a series of challenges for data sourcing and validations, including market data feeds, broker screens / vendor data for new products, as well as data sets to support complex multi-curve construction.
- Primary Trading Systems – varied configuration changes and re-tooling requirements for platforms (both in-house built and vendor products) used to price, capture and execute trades on ARR-referencing products.
- Risk Management – wide-ranging system changes will be required reflect changes to product valuation and risk management models. In addition, historical data sets for key risk model conventions will need to be accrued and added to libraries over time.
- Post-Trade Processing – back-office platforms will need to support the booking, processing and valuation of ARR-referencing products, as well as accommodating the bulk novation of contracts and trade documentation that reference legacy IBOR products.
- Treasury & Asset Liability (ALM) Management Systems – adaption of Treasury management and supporting platforms to accommodate ARR-referencing products, thereby enabling key ALM processes including balance sheet funding, hedge accounting and cash-flow forecasting.
Technology teams that support Sales & Trading platforms are bracing themselves for broad portfolios system reconfiguration and re-tooling requirements.
The central role that Primary Trading Systems (PTS) now play in the management of front-to-back trade flows for IBOR-referencing products means that these transition requirements will extend well beyond just pricing and deal capture functionality.
The breadth of potential IBOR transition requirements in the Front Office domain is summarised in the following diagram:
In addition to framing and prioritising portfolios of system reconfiguration and re-tooling changes, I anticipate that Front Office changes teams are likely to be involved in the following activities:
- Constructing accurate inventories of impacted trade populations across products, trading desks, lines of business, geographies
- Defining conversion approaches across products and asset classes – complex products (for example, swaptions) will be managed as ‘exceptions’ to ‘vanilla’ conversion approaches
- Unwinding or terminating and potentially rebooking open trades that reference legacy benchmark rates
- Negotiating (potentially with third party arbitration) new ARR-referenced spreads for rebooked deals
- Creating new products that reference new benchmark rates across currencies
Starting the Libor Transition Journey
Investment banks with Rates and Fixed Income trading businesses will be most obviously impacted by IBOR transition, but the impact will extend to any Financial Services organisation that uses IBOR-referenced benchmarks to value its product portfolios.
Despite their size larger FS organisations, with more mature change delivery capabilities are best placed to meet the IBOR transition. Many smaller FS organisations, perhaps lacking experience in complex programme delivery will feel the burden of IBOR transition more acutely.
However, despite these challenges there are series of practical steps that multi-disciplinary change teams can take now to prepare their organisations for the impending Libor Transition journey:
- Perform a ‘scan’ across businesses to assess likely transition challenges and key impacts across front-to-back processes and system flows
- Determine how to amend legacy contracts to reflect ARRs, including hedge accounting treatment
- Create inventories of legacy benchmark usage across products, calibrate exposures linked to legacy benchmark products
- Ensure robust written contingency plans are in place in the event that a legacy IBOR rate materially changes or ceases
- Develop a phased transition ‘playbook’ so that a transition programme can be mobilised and executed efficiently
Launching a coordinated approach to Libor Transition planning and analysis now will enable Financial Services firms to take the initiative on this complex and multi-dimensional marketplace challenge.