IBOR – Replacement by new reference interest rates
Replacement of IBORs with alternative reference values (RFRs)
Aim of the conversion and which requirements are there?
Trader-led manipulation of the LIBOR revealed the vulnerability of a private-sector investigation of the IBORs in the recent past. The sharp decline in transaction volumes associated with the loss of confidence led to the recommendation of the Financial Stability Board to replace this practice in the various currency areas with a transaction-based, and thus less manipulable, reference rate method. Deployed working groups have defined methods for the respective currency area for the tamper-proof determination of risk-free rates.
In addition to the methods, the working groups have already set the timelines for the replacement of the existing IBORs. This increases the pressure to act, especially for those financial market players for whom multi-currency RFRs are relevant. Against this background, affected contracts must be analysed and products and processes need to be adapted.
Subsequently, the expected challenges will be outlined using the example of the new hybrid EURIBOR. For the euro area, benchmarks from 2020 onwards must be determined precisely and with integrity, in line with the 2016 Benchmark Regulation (2016/2011). According to the current understanding, in addition to a transaction-based determination based on market data, a comprehensible estimate also fulfils this requirement. The EMMI, as the responsible working group, has defined the parameters for the determination of the hybrid EURIBOR in three levels. In addition to using transaction data from the Money Market Statistical Reporting MMSR (Level 1), the EMMI will allow transaction data from near-money market transactions between financial institutions, e.g. Floating Rate Notes from other data sources (Level 2). Also permissible in the case of non-representative reproducibility, Level 3 also estimates the refinancing costs of the panel banks involved. However, the test phase has produced a disproportionate share of estimates (between 57% - 83%)1 which makes a FSMA approval questionable as benchmark-compliant. Alternatively, the use of the ESTER as a basis for EURIBOR-equivalent forward interest rates is considered as a fall-back scenario.
1Results of the EMMI testphase, showed in Regulierungsnewsletter Börsenzeitung 30.10.
Challenges for European Financial Institutions
The introduction of the new RFRs requires consideration of multiple aspects and areas within financial services providers and their market environment. By way of example, the following points may be mentioned:
- Milestone planning of the implementation of requirements considering the different timelines of the respective working groups
- Review and reorientation of internal hedging and (re-)financing strategies
- Adjustment of internal pricing models for the valuation of products and positions
- Analysis of the impact of the replacement of the existing IBORs considering different market conditions (currencies, indices, legal frameworks, customer segments) and decision making on the strategic approach
- Examine and adjust the legal framework of client and counterparty relationships to minimize potential legal risks
- Identification and analysis of the product landscape on the assets, liabilities and refinancing side of the financial institutions regarding any necessary adjustments
- Identification and adaptation of affected processes, IT systems and data interfaces
- Analysis and decision on how to deal with the transitional parallel validity of IBOR and RFR-based reference interest rates (fallback scenarios)
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Based on years of experience in the implementation of regulatory requirements and the associated expertise, we have developed an analysis methodology that enables us to efficiently identify new requirements and implement them immediately. In addition, we are also able to perform optimizations of existing setups.
In addition, we have extensive expertise in European reporting requirements and in in-depth settlement and product experience.
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