A long way to go for Libor transition as key deadline approaches


With less than 100 days to a key deadline, banks are moving away from the world’s highest interest rate more slowly than regulators had hoped.

Despite years of preparation and trial and error, many new US bank loans still use the London Interbank Offered Rate, or Libor, which is being phased out globally after a rate manipulation scandal years ago.

The limited progress is “disappointing but not surprising” and reflects the enormous challenge of moving lenders away from a benchmark they have used for decades, said Kathryn Judge, a professor of law at Columbia University who focuses on law. financial stability.

It also prepares bankers for a potentially hectic end to the year as they struggle to explain the changes to commercial borrowers – some of whom are less prepared than others – during loan negotiations. Regulators stressed that banks should not grant new Libor loans after December 31, as this “would create risks to safety and soundness.”

The Libor loans banks are extending today include fallback options in the event that Libor eventually disappears, reducing the possibility of market disruption, and activity in non-Libor lending is expected to resume in the coming weeks.

But so far, banks have yet to consider using benchmarks other than Libor – either the one that regulators have implicitly pushed, or one of two competing rates that have gained traction. – when granting loans.

The transition is happening more quickly in the much larger derivatives market, where the US version of Libor supported more than $ 200 trillion in contracts last year, compared to just $ 6 trillion in loans. Analysts say the derivatives market is increasingly adopting the Guaranteed Overnight Funding Rate, or SOFR, the benchmark that a US group of market participants called by the Federal Reserve in 2017 to replace Libor.

But banks have been hesitant to walk away from their use of Libor in lending documents, even as regulators have raised concerns for months about the pace of the transition.

“Deniers and laggards engage in magical thinking. LIBOR is over, ”Fed vice chairman for oversight Randal Quarles said in June.

Many banks declined to comment on their Libor transition plans for this story. Some said they started making non-Libor loans months ago or would increase this activity in the coming weeks.

The transition is expected to accelerate – and soon. Many banks have set internal deadlines in October or November for their teams to move away from granting Libor loans, according to executives and bank advisers who work with them.

Even so, some individual bankers and their corporate clients may not respond with a sense of urgency, according to consultants and industry lawyers.

Some large companies have been following the obscure details of the Libor transition closely, but other companies are only vaguely aware of it. The internal financial systems of these companies may also not be ready for the transition.

“There is a lot of operational complexity,” said Venetia Woo, senior director of consulting firm Accenture. This is true not only for financial institutions, but also for corporate treasurers who borrow from banks, she added.

Tom Wipf, who chairs the committee convened by the Fed to plan the transition to Libor, said he had long advised banks to “stop digging the hole” by increasing their exposures to Libor. Still, the new Libor loans have strong fallback language that will switch borrowers to a non-Libor rate when the soon-to-disappear benchmark disappears, he noted.

“Inertia on the loan market”

Regulators have publicly expressed concerns about the slow pace of the transition in recent months.

Loans that are based on benchmarks other than Libor are “not where they should be at this point” due to “inertia in the lending market,” said Michael Held, Federal Reserve legal counsel. Bank of New York, in a September 15 press release. speech. Treasury Secretary Janet Yellen said in June that business loans were “well behind” in the transition away from Libor.

Dueling deadlines set by regulators didn’t help, the judge, a law professor at Columbia, said. Regulators have made it clear that banks cannot grant new Libor loans after 2021, but they have decided to let old contracts continue to reference Libor until mid-2023 to ease the transition.

The latter deadline reduced the urgency for some companies who thought they were “off the hook” to quickly make the investments needed to deal with the change, said Bradley Ziff, senior advisor at consultancy Sia Partners who interviewed dozens of banks. on their Libor transitions.

These borrowers’ understanding of relevant maturities has improved, but it has slowed their progress “significantly,” he said.

Another source of confusion has been the existence of several options to replace Libor, according to Ziff.

U.S. regulators have long encouraged banks to switch to SOFR, which is based on transactions in the massive U.S. Treasury securities market, rather than estimates from a limited set of large banks – a thin set of calculations that has finally opened the door to the manipulation of Libor.

But banks can choose from a few SOFR variants when making loans. There’s also Ameribor, an American Financial Exchange benchmark that’s preferred by some regional banks because it’s tied to their actual borrowing costs. More recently, Bloomberg launched its own benchmark called BSBY, which has gained momentum among banks.

“Customers say, ‘Well, how do I know there won’t be another shoe to drop? “, Ziff said.

Bank management may also find themselves in a somewhat different position than commercial bankers who work on transactions themselves. Bank account managers have been a little reluctant to charge non-LIBOR rates to clients, wary of any setbacks or legal action if they “accidentally sell or misrepresent a product due to lack of understanding. “Ziff said.

Some banks are more advanced than others. KeyBank’s Cleveland-based commercial real estate group began making SOFR loans last December, and the vast majority of its loans no longer use Libor, said Andrew Lucca, West Regional Director of KeyBank Real Estate Capital.

“It was a slow process, but we did it because we wanted not only to make our clients feel comfortable with the change, but also our bankers,” he said. “Because when you go from a rate that’s been around for a long time, it takes time to fix the issues. “

Truist Financial in Charlotte, NC began offering SOFR loans in October 2020 and this quarter rolled out other options including Bloomberg’s BSBY rate. Regions Financial in Birmingham, Alabama, told clients earlier this year that it would stop issuing Libor loans after mid-September.

The Phoenix-based Western Alliance Bank has been discouraging Libor lending since mid-year, according to Treasurer John Radwanski, who said much of the bank’s new loans no longer use Libor.

“It will come quickly”

A catalyst for change in the coming weeks will be banks’ efforts to start using a forward looking SOFR option, which was not ready until the end of July, but which the banks believe is a much more viable option for lending. .

Bankers have long criticized SOFR for its lack of a forward-looking option, which would tell borrowers in advance what rate they would pay for the next month or more, much like they can get with Libor options at one point. month.

But regulators had pushed banks to adopt SOFR without waiting for the forward option, known as the “SOFR term,” which needed more momentum in the derivatives market to build.

However, the regulators’ message did not resonate with some banks. An official at a medium-sized bank, who did not want to be identified, said the bank “held the term SOFR as long as possible.”

The bank began supporting SOFR term loans in September, two months after the Fed-convened group of market players known as the Alternative Benchmark Rates Committee officially recommended a SOFR term rate. .

“Although we haven’t booked much yet, it is happening and it will happen quickly,” said the head of the midsize bank.

The delay in obtaining a forward SOFR rate was largely due to a “chicken or egg” issue, observers said. The SOFR derivatives market, which banks can turn to for protection against interest rate risk on any loan, was not robust enough at the start of the year due to a shortage of SOFR loans. But banks were reluctant to grant SOFR loans without a deep derivatives market to hedge the risks.

But the growing dynamics of the SOFR derivatives market quickly changed the situation and led the Alternative Reference Rate Committee to formally recommend a forward SOFR rate. In a July 29 statement, the group said market players “now have all the tools they need as we move into the transition towards the end of the transition.”

Banks are working hard to meet upcoming deadlines, but adopting new rates requires a massive operational effort to prepare staff, systems and clients, said Meredith Coffey, executive vice president of the Loan Syndications and Trading Association . Coffey is co-chair of the Fed’s committee task force on business loans.

“Adopting a new rate is like spinning a battleship,” she said.


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