by Joe Posavec, Managing Director, Special Opportunities Group
There are currently several big changes on the horizon that will have a profound impact on banks and other financial institutions. High on this list and with global impact, is the transition away from the London Inter-Bank Offered Rate index (LIBOR). At just about every banking industry conference in the past year, discussions on this issue have become much more pronounced.
LIBOR index is the primary benchmark used to set short-term interest rates around the world. It’s currently estimated that there are somewhere between $200 trillion and $350 trillion of loans and credit facilities tied to this index (for reference, Global GDP in 2018 was around $85 trillion).
The issue arose due to some fundamental flaws that allowed for market manipulation of the index. Therefore, LIBOR may not be published after December 2021, and the financial services sector is woefully unprepared for its demise.
At present in the U.S., the Alternative Reference Rates Committee (“ARRC”) has identified the Secured Overnight Financing Rate (“SOFR”) as the LIBOR replacement for derivatives. However, there is no clear successor to LIBOR for traditional bank lending as SOFR’s volatile structure does not fit well in to this segment.
At the recent Risk Management Association (RMA) annual conference in New Orleans, the Office of the Comptroller of the Currency (OCC) panel raised this as one of their key discussion points. Their plan for 2020 is not to formally review the banks on the transition, but to have discussions with the expectation that banks outline a clear transition plan. Some of the key questions we noted by the panel are listed in the sidebar.
The questions highlight key concerns around potential risk to the bank not only form the regulatory side, but also from the legal side. That is why one of the critical questions will be if the bank has engaged their Compliance, Risk, and Legal departments in the transition plan.
In our regulatory diligence and advisory role, we have seen a variety of approaches to this by our banking clients. Some of them have moved forward with a clear focus on this issue while others appear to be using more of a wait-and-see approach. Best advice to the latter would be to get on track quickly.
The starting point should be to identify the affected loan population and determine if it contains sufficient fallback language. That will give you a clear idea of how big of an issue you are facing. It will also provide a basis for resource planning, potential risk, how much time will be needed to complete the transition, and basic budget requirements.
As we move forward to the 2021 deadline, you must make sure you have allocated sufficient resources and time to complete this transition. You will need to address the outlined questions confidently, not only with regulators, but also with internal committees during the transition process.
Joe Posavec is a Managing Director in Cushman & Wakefield’s Special Opportunities Group – Bank Advisory. He manages teams of industry consultants assisting banks in their regulatory compliance. Joe has vast experience in different levels of banking that include asset and portfolio review, loan sale diligence, commercial underwriting, Reg H flood compliance, AML and bank M&A transactions.