The use of LIBOR (London Interbank Offered Rate), global interest rate benchmark, is set to be replaced in December 2021. SONIA, SOFR, ESTR and TONAR will be taking the place of LIBOR’s place. This is one of the largest structural changes in the financial world encompassing $ 350 trillion in financial contracts linked to LIBOR. The US, the UK, Switzerland, Europe and Japan have made the most progress.
There are some major challenges that are to be dealt with. Operational challenges, regulatory challenges, and transitioning financial contracts are some of the riskiest aspects involved. Add to that different RFRs for various countries. The issues that could arise out of the transition are multi-dimensional, spanning institutions, products and business lines. It will impact institutions, such as banks, insurers, corporates etc. who have exposure to IBOR. This includes loans, foreign currency debts, structured products, bonds etc. These changescan also affect multiple aspects of business, like risk management, accounting, tax, and legal functions. India has to face many of the above-mentioned challenges as well.
Even though Indians are aware, they are not as ready for the transition. Those who have international exposure will have to be ready whether India regulators start a transition or not. Work is being done in the international level to help smoothen the transition. ISDA, IASB and other independent bodies havepublished consultation documents, term rate calculators and guidance that can help with the transition.
Various benchmarks like SONIA, TONAR, SOFR, ESTR will be available. So how will a borrower choose from the same?
Each country has its own benchmark rate which is now being replaced for their currency. Thus, borrowers do not have much choice if they are transitioning contracts from former regime. Depending on the country, the replacement rate is fixed.The move from IBOR to RFR is not fixed, herethe market participants have a choice.
Contracts that expire beyond 2021 have 2 possibilities, for short term contracts that have fallback provisions can delay the transition, but for long term cases, factors like the best alternate rate and spread adjustments that capture the risk characteristics of the erstwhile IBOR rate have to be considered.
