4 steps corporates should take to prepare for LIBOR transition

in Audit, Financial Services, 25.03.2019

It’s clear the LIBOR transition will have a huge impact on financial institutions. But corporates aren’t immune to the changes. Have you assessed how the LIBOR shift will impact your business? Find out what steps your business can take to stay ahead of the curve.

The discontinuation of the London Interbank Offered Rate (LIBOR) after 2021 exposes corporates to a variety of risks and has generated a lot of unanswered questions. LIBOR is still currently quoted for USD, EUR, GBP, JPY and CHF and several tenors (primarily 1, 3, 6 and 12 months) continue to operate as if there’s no end in sight. Yet, the discontinuation of LIBOR will impact corporates with far-reaching implications for commercial, legal, tax and accounting areas.

Despite the ambiguities, the LIBOR transition has already reached a few milestones – various central banks have now found their proxies for an alternative, nearly risk-free rate (CHF SARON, GBP SONIA, USD SOFR, JPY TONAR and EUR ESTER).

The LIBOR transition has a huge impact on financial institutions. But, the impact on corporates may also be significant, keeping treasurers busy over the next 2-3 years. Right now, corporates should observe market practices and timeline updates to evaluate the LIBOR shift’s impact on their operations and how should they plan for the transition.

To best prepare for the LIBOR transition, we recommend taking the following actions:

1) Define your exposure to LIBOR

LIBOR has become the reference rate for many cash and liquidity instruments, mid- and long-term funding including lease liabilities, trading and hedging derivatives, inter-company funding, commercial and procurement contracts or provision calculations. For all of these areas, you should review your current contracts and agreements to determine what actions are required and how a fall-back scenario must be negotiated with counterparties.

Given the broad implications, we recommend you start by educating all key stakeholders among the entire value chain to ensure all relevant areas are captured. This includes cross-functional collaboration between treasury, tax, controlling, procurement, credit- and transfer pricing teams. Additionally, you must get business cooperation (e.g. joint ventures) on board in case they have their own financing.

2) Measure your transition efforts

Defining your exposure to LIBOR will facilitate the impact assessment to determine how much effort must be invested. Those efforts depend to what extent the following areas need to be adapted:

  • IT tools (e.g. TMS, ERP, etc.)
  • Valuation models (e.g. adjusted interest curve, etc.)
  • Hedge accounting (e.g. measurement of hedge effectiveness, etc.)
  • Tax (e.g. treatment of debt instruments, etc.)
  • Collateral management (e.g. interest calculation of cash pools, etc.)
  • Pension models (e.g. method to calculate future pension benefits, etc.).

Once you’ve determined those efforts, make sure that: project leaders are designated; Senior Management is aware of actions that need to be undertaken and followed; and, a proper budget allocation has been decided for the transition.

3) Build a plan and prioritize exposure change

While it’s still early in the year to fully engage in transition efforts, it’s not too early to establish a timeframe for the action points described above. Identify and prioritize areas with significant impact. On the most significant exposures, start to design go-live scenarios. Corporates should also seek to minimize any new exposure to LIBOR by choosing financial instruments and entering into contracts which already reference replacement benchmarks.

4) Stay on top of latest developments

Closely follow the next developments of the LIBOR shift and discuss them with your counterparties such as banks, auditors, lawyers or system providers.

Expect to see the following announcements in the next 3 to 6 months:

  • The EURIBOR replacement rate, expected October 2019 (ESTER standing for EONIA) at the latest
  • ISDA’s supplemental consultation on USD LIBOR feedback
  • Further feedback from market participants on the RFR valuation methodology (parameters of the historical mean/median approach to the spread adjustment)
  • ISDA amendment of its standard definitions
  • IASB Exposure Draft on amendments of IFRS 9 hedge accounting.

 

Stay up to date and gain insight into the latest LIBOR developments by reading our articles and visiting our website.

 

 

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