With the London Interbank Offered Rate (LIBOR) ceasing to exist at midnight January 1, 2022, financial services firms around the world are faced with an enormous data management challenge. LIBOR, and the interest rate curves built off of it, are used within a wide variety of financial instruments and products, including derivatives, loans, and bonds. All of these – LIBOR is estimated to be woven into some $350 trillion of financial contracts – will have to transition to another benchmark rate. The data management implications of this are enormous. Firms’ data teams, already struggling to keep up with the pace of regulatory change, have just seen their “to do” list expand significantly.
Adding to the challenge is that regulators are also seeking to change the way that financial firms price financial contracts. LIBOR is typically used derive term rates, while its GBP and USD replacements – the Sterling Overnight Index Average (SONIA) and the Secured Overnight Financing Rate (SOFR) – are based on overnight risk-free rates. The scale of the challenge is being compared to the initial introduction of the EU’s euro currency, with a bit of extra excitement thrown in. “The impact of the shift away from LIBOR will be felt not just by investment banking and capital markets, but also by wealth management and retail financial services too,” says Chris Beer, EMEA regulatory practice head at Luxoft. “The complexity lies in working out exactly how the transition away from Libor going to impact a particular line of business. The entire way that many industry participants value financial contracts across a range of asset classes and, as a result, manage their business, is going to change.”
“If the impact analysis has not already been done or is not already underway, then the bank is probably in trouble,” says Charlie Browne, head of market and risk data solutions at GoldenSource. “This is a data project. Firms need to look at where the LIBOR curves exist in systems in the business. Is there lineage from the centralized master system all the way through to the systems that are impacted by the LIBOR curves? If there isn’t, how does the firm get that lineage in place so that a program can be structured to get the business off of the LIBOR curves and onto the new reference curve?”
In the short term, “firms have to transition between two sets of interest rate curves and reconfigure the construction of their current curves,” says Martijn Groot, vice president of marketing and strategy at Asset Control. “And many systems have not been designed to cope with transitions like this. In terms of impact, it can be compared with the introduction of the euro 20 years ago. Firms will need to review their pricing, risk and front office systems, to see where curves are used for impact analysis and a smooth transition.”
Also, changing benchmarks isn’t just a matter of replacing one number with another – because LIBOR and its replacements are different kinds of benchmarks, their timing (when the rates are made available) and the term structure they cover differs. The benchmarks are also “a different animal in terms of valuation,” says Beer. “They will behave differently. This has important implications for the way banks undertake risk management in different market conditions, and the way they value their businesses.” Specifically, firms should consider the impact of these new benchmarks on their Fundamental Review of the Trading Book (FRTB) and BCBS 239 programs, adds Browne.
The bigger project lies in the need to reconfigure market data management overall. Today, most firms have multiple places across different business lines and geographies that calculate interest rate curves based on LIBOR, and then use those different curves for their financial contracts. Instead, from an enterprise data management perspective, firms should seek to have one central place where the new benchmark interest rate curves are created, and then that data should be propagated across the organization to all of the different systems that utilize it, says Browne.
On top this, firms operating within the EU will need to be sure that they are compliant with the EU Benchmarks Regulation, which applies to benchmark administrators, supervised contributors, and benchmark users. For example, transition programs for benchmark users will have to be conducted within the rules, according to Groot. As well, firms will have to be sure they put in place a governance structure to track ownership of benchmark data within the firm and manage its use. Says Groot, “Strong audit trails will be required for the ways in which this transition is managed.”