Why LIBOR Transition?

Hey Friends,

Before understanding the LIBOR transition to SOFR, you should know what is LIBOR? Global banks mark their transactions using the benchmark rate known as LIBOR. It is the average interest rate provided by prestigious UK banks. All LIBOR settings, according to the FCA, will either stop being provided by any administrator after or cease to be representative.

In India Banks and other regulated companies, it was advised by the Reserve Bank of India (RBI) to avoid signing new financial contracts that use the London Interbank Offered Rate (LIBOR) as a benchmark in a statement they released on July 8.

The movement of financial institutions across the globe from outdated benchmarks to fresh alternative reference rates was made possible by the guidance.

The benchmark rate used by all international banks is called LIBOR. In order to manage potential risks to customer protection, reputational risk, and litigation risk, as well as to prevent disruptions to the safety and resilience of financial institutions and the overall financial stability of the economy, the RBI claims that the move away from LIBOR and the adoption of accepted alternative reference rates (ARRs) developed in various jurisdictions, are significant and require careful preparation.

The RBI urged banks and financial institutions to evaluate their LIBOR exposures that would mature after LIBOR was discontinued in August 2020 and to develop a strategy that had board approval for the activities that would be taken to mitigate any risks that might arise during the transition. The regulator has just updated its advice to banks on how to get ready for the change.

What is stated in the most recent RBI advisory?

The RBI stated that as soon as practically possible and, in any case, by December 31, 2021, banks and financial institutions must stop entering into new financial contracts that utilise LIBOR as a benchmark. Instead, they must start using any widely recognised alternative reference rate.

All financial contracts that reference LIBOR and those maturing after the indicated discontinuance date should include strong fallback clauses, the RBI warned banks and financial institutions.

The Mumbai Interbank Forward Outright Rate (MIFOR), a benchmark that uses LIBOR, has also been instructed by banks to stop using it as soon as is reasonably possible and, in any case, by December 31, 2021.

There isn't a definite agreement on the new ARR. However, it is widely anticipated that the Secured Overnight Financing Rate, or SOFR, will be adopted as the new benchmark rate. An identified substitute for USD LIBOR, which is scheduled to phase out at the end of 2021, is SOFR, which is tied to US government market transactions.

SOFR has begun to replace LIBOR at major Indian banks including the State Bank of India. SBI said that two interbank short-term money market transactions with pricing based on SOFR were completed on January 20.

The first interbank money market transaction connected to SOFR, according to ICICI Bank, was completed on January 21. The transaction, carried out by the bank's Hong Kong branch, is a component of its benchmark transition management plan to evaluate readiness for a seamless switch to the new ARR, according to the bank.

What is the impact of LIBOR transition:

To price foreign transactions and when issuing other financial instruments, banks frequently use benchmark rates like LIBOR. They must as soon as possible decide on a new benchmark rate to prepare for a transition and reduce potential transaction risks. Banks will need to update their systems and contracts.

Since LIBOR has been around for a while, banks will have a difficult time making the switch before the year-end deadline. The same is valid for big businesses considering overseas borrowings or bond issuances.

I would like to conclude here as I believe this suffices your query about the LIBOR transition to SOFR.

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