Business loans are ‘particularly slow’ to switch from LIBOR, posing risks: FSB


Dive brief:

  • US companies and banks have not acted quickly enough to initiate the switch from the London Interbank Offered Rate (LIBOR) to a new benchmark rate, the Financial Stability Board (FSB) declared, warning of potential market turmoil as the scheduled end of LIBOR approaches on December 31.

  • “The business loan market has been particularly slow to begin the transition” from LIBOR to a new benchmark rate, according to the FSB, a watchdog that includes the Group of 20 nations and the European Commission.

  • “Most banks continue to offer LIBOR as a primary or only option for variable rate commercial lending,” the FSB said, adding that “borrowers report that lenders have provided them with limited information on alternatives to LIBOR.” .

Dive overview:

TThe Federal Reserve and the US Treasury have warned of potential market turmoil if corporate borrowers and financial institutions fail to switch from LIBOR to another benchmark rate before it is phased out later this year. . LIBOR is the benchmark rate for trillions of dollars in mortgages, derivatives, business loans, and other financial contracts around the world.

Regulators have adopted the Secured Overnight Financing Rate (SOFR) as a substitute for LIBOR, which is derived from London banks’ estimates of what they would be charged when borrowing from other banks. The SOFR is based on overnight repurchase agreements secured by Treasury bills.

Use of SOFR has overtaken LIBOR in issuing variable rate notes, and the market for variable rate mortgages “is moving rapidly” to the new benchmark, the FSB said.

SOFR is gaining ground in derivatives markets – with more than $ 6 trillion in open interest in SOFR-based derivatives – but is still far from eclipsing LIBOR. In addition, securitization issues and corporate loans in the United States are still largely tied to LIBOR, the FSB said, warning of the dangers of slow SOFR adoption.

“Given the magnitude of the risks associated with an inability to adequately prepare for the LIBOR transition, it is now incumbent on companies to act.” the FSB said on July 6. “There should no longer be any doubts about the urgency of the need to move away from LIBOR by the end of 2021.”

For more than three decades, financial institutions and corporate treasurers have integrated LIBOR into a full range of contracts. Such widespread and proven use – along with the mixed acceptance of SOFR and competition from other benchmarks – has complicated efforts to ensure the smooth adoption of a new benchmark.

Regulators began to consider phasing out LIBOR after a manipulation scandal in 2012. Despite this tampering with LIBOR, financial institutions and corporate treasurers have delayed the move to SOFR because it lacks some of LIBOR’s attractive features.

The LIBOR rate, as an estimate of borrowing costs between banks, reflects credit risks and can be expected in three, six and 12 months.

Based on transactions on the Treasury securities buyback market, SOFR does not reflect credit risk and does not facilitate the creation of a term structure allowing corporate treasurers and financial institutions to perform forecast rate calculations.

The Fed has told banks not to use LIBOR in financial contracts after the December 31 deadline, even though SOFR has yet to become the dominant alternative rate in debt markets. Final fixings of most LIBOR rates – including one-week and two-month US dollar LIBOR – will be effected on December 31, 2021, but other US dollar maturities may continue until June 30, 2023.

Market stability depends on phasing out LIBOR, the FSB said. “The continued dependence of global financial markets on LIBOR presents obvious risks to global financial stability. “


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