Corporates know transition from Libor is painful but necessary

It used to be all so simple. Corporates, wanting to borrow at a floating rate, could take out loans or issue bonds safe in the knowledge that it could be underpinned by Libor, a benchmark that, for all its flaws, was easy to use and used the world over.

No longer. Libor, or to give it its full name the London Interbank Offered Rate, is in its death throes.

The UK’s Financial Conduct Authority said in March that from December 31 most of its 35 daily fixings of rates, which are meant to represent the cost of unsecured borrowing in different maturities in five of the world’s most important currencies, would cease to exist.

Some of the most crucial fixings, involving US dollar Libor, are due to be phased out in the middle of 2023.

So is the corporate world prepared? No.

That’s not down to a lack of trying. Corporate treasurers (and their lawyers and lenders) have had to spend a great deal of time rooting out Libor obligations, which over the course of the benchmark’s life made it into every nook and cranny of the global financial system.

“We started transitioning in 2018, and we’re still going,” said Shaun Kennedy, group treasurer at Associated British Ports. “We have a lot of Libor exposure — loans, bonds, private placements with US investors — a bit of everything. We’re having to go through every single one, it’s an unreal amount of negotiating.”

There’s been progress. Obligations linked to the UK’s replacement benchmark, Sonia, are now common and have become the norm for new issuances in markets such as UK corporate debt.

“The FCA announcement has focused minds,” said James Leather of Corium Treasury, who is helping businesses handle the transition. “The conversations between lenders and borrowers on how to move to Sonia are becoming more and more constructive.” Companies are becoming increasingly confident in hedging their Sonia exposures, too.

Yet several challenges remain. One is the transfer of so-called tough legacy contracts, which, should Libor cease to exist, contain either no fallbacks or woefully inadequate ones.

In the US, bodies tasked with handling the transition have passed legislation to amend some contracts, but not everything is covered by the new laws. In the UK, there is a lack of clarity, leading businesses to put off work.

“You don’t want to go through the effort of transitioning to something, spending all that money and time, and then find out that you didn’t need to,” said Sarah Boyce, of the Association of Corporate Treasurers. “Clearer definitions of what’s going to count as tough legacy would be really helpful.”

Another big problem is that some current benchmark replacements do not at present include so-called term rates like Libor, which enable borrowers to fix the rate they will pay over a set period, say three months.

Instead, Sonia and other alternatives are often used in a backward-looking way, taking an average of short-term rates over the borrowing period. This means the size of the repayment is only known days before it is due, creating uncertainty for business. Markets such as trade finance would particularly struggle with such a scenario.

In the US, meanwhile, multiple benchmarks are vying to succeed Libor, delaying transition and ramping up the cost of hedging exposures. To speed it up, officials at the Commodity Futures Trading Commission have recommended interdealer brokers switch their swap trading conventions from Libor to Sofr, the officially endorsed US alternative, on July 26.

If that happens, Tom Wipf, chair of the Alternative Reference Rates Committee, a public-private body set up to handle transition, thinks they could recommend a term rate linked to Sofr “days, not weeks” after the switch.

“The sooner there is a term Sofr, the better,” said Boyce, adding that this would help settle the market down. ”[Moving on from] dollar Libor is the biggest challenge, primarily because it just blows everything else out of the water in terms of scale.”

Yet, for all the chaos, treasurers want transition. Libor, a metric based on slim volumes of actual transactions, set by a small group of bankers from 20 lenders ensconced in towers in the City and Canary Wharf, was not fit to play such a gigantic role in global finance.

“We want a robust rate that’s transparent,” said Kennedy. “There were lots of things I didn’t like about Libor. The transition definitely is a step forward, even if it’s taking a long time.”

claire.jones@ft.com