Libor: where are we eight months later?  - Flow / cash management > Treasury

Libor: where are we eight months later? – Flow / cash management > Treasury

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The Libor interbank rate, a global reference that has become controversial after numerous scandals, has not been usable for certain currencies since December 31, 2021.

The “London Interbank Offered Rate» has long been a reference interbank rate in the world of finance, used to price loan contracts, currency hedging, multi-currency contracts, derivatives. Eight months after this upheaval, where are we?

For financial departments, the first headache is based on listing all the financing contracts, derivatives that support the Libor positions. ” There are extensive legal work to be carried out with the treasury teams to ensure that each of the positions is identified, that the contractual documentation supporting the transactions is adjusted”explains Charles Sicaud, vice-president of the AFTE risk commission and front office manager in a large industrial company.

Change software

The other big issue involves the IT development. A practical difficulty, which requires modifying the configuration of the system, changing the calculation methods, since it is now necessary calculate interest at the end of the period. The Libor was indeed determined at the beginning of the interest period, and paid at the end. The rates are thus calculated at the end of a given observation period, from day-to-day rates that have actually been observed, and not on the basis of expectations of what the level of these rates would be. ” We do not know the interest rates in advance. We therefore calculate the interest rate based on the previous period to apply it to the next one. This technique is limited to intra-group transactions because the banks don’t accept itrelates Charles Sicaud. The challenge is to know if the rate applied is a market rate or if it moves away from it? »

A blur around the methods of calculating interest

On the part of derivative contracts, other conversion terms have been defined with the banks. For several years now, the market has been preparing for this transition. Among the best practices noted by the European Central Bank is the introduction, almost systematic since 2018, of fallback clauses (fallback) in contracts. The latter provide, in the event of the disappearance of the benchmark index used in the contract, a substitution mechanism for designating a replacement rate. Six months after the abandonment of Libor, there are, however, certain disparities in the transition methods applied. ” The basic rules on the application of the rate adopted by the LMA (Loan Market Association) and the International Swap Dealers Association (ISDA), one of the most important professional associations in finance, are not the same. They gave birth to different interest calculation methods, sometimes with a lag of a few days on the SOFR rate, intended to be used for derivative contracts. “, reports Charles Sicaud.

The American regulator has also constructed this new daily index, which forces financial departments to produce capitalization calculations to determine the accrued charges at the end of the period. ” We operate in a market where the regulator relies on the daily SOFR rate, which allows to know the rate from the beginning of the period. But banks and financiers offer a prefixed alternative, the Term SOFRwhich brings confusion and which induces for the treasurers additional cash costs to manage these different indices », concludes Charles Sicaud

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