Life after LIBOR: Are you ready?
The end of the London Interbank Offered Rate (LIBOR) as a benchmark in the not-so-distant future will have a significant impact — directly or indirectly, depending on country product conventions — on some mortgage lenders and their customers. LIBOR plays an important role in financial markets, acting as a reference rate for cash products and derivative contracts held by a wide array of market participants. It is extensively embedded throughout a range of processes, systems and models across industries and market segments. However, there’s no need for alarm. Forward-thinking lenders still have time to take action and prepare for a smooth transition
LIBOR, a measure of the average rate at which banks are willing to borrow wholesale unsecured funds, is no longer considered a reliable global interest benchmark. After more than 40 years of operation, LIBOR will cease to exist as a benchmark at the end of 2021. The consequences will be far reaching: LIBOR is currently used to price about USD 370 trillion of financial contracts daily. It also serves as a critical benchmark rate-of-performance measurement for investment securities and as a proxy rate for wholesale funding. Estimates suggest that there are about 200,000 LIBOR-linked residential and buy-to-let mortgages in the UK market, and each of these will need to be redeemed or transitioned to an Alternative Reference Rate (ARR), such as the Bank of England’s Sterling Overnight Index Average (SONIA).
DXC Technology has been working with Stratagem Partners to build and pilot methodologies, tools and models to assist banks in addressing their LIBOR transition requirements. Based on this work, our overriding observation is that the impacts of a transition are significantly more extensive and complex than many customers expect.
LIBOR is deeply entrenched within the operating models of many mortgage lenders. Changing to other, less mature benchmarks creates market and operational risks and raises concerns for market stability. Transitioning to SONIA or other benchmarks has an impact on how lenders will price mortgages, appraise suitability for customers and manage risk. Other complications further compound transition risk: trigger events; third-party dependencies; and economic, financial, legal and regulatory considerations.
Typically, existing contractual fallback provisions have not considered the permanent disappearance of LIBOR. As a result, problems are likely to surface when it goes away: unforeseen procedural gaps, economic transfer issues dealing with LIBOR’s adjustment spreads, and conduct and litigation risks.
Many lenders can ill afford to waste time and must urgently start remediation activities if they are to beat the 2021 deadline. Implementing potentially largescale product, transaction, technology and process remediation, however, presents considerable execution risk.