QOTD -- The #LIBOR Trifecta
The summer saw a steady drumbeat of activity related to the LIBOR transition. The Federal Reserve Bank of New York hosted multiple webinars, the ECB released its expected consultation on compound term rates, and the Bank of England held its regular meetings (but released minutes only with a three month lag).
In the last few weeks (August and September), Asian policymakers and EU regulators have joined the party with a trifecta of activity that delivers fresh data and warnings to the industry. Discovered using our PolicyScope Platform, and placed on the radar screen for our daily PolicyScope Risk Monitor users, our data tribe has seen the global round robin of activity maintain significant but subtle momentum throughout the summer.
Our time series data illustrates the point. Throughout the summer, we saw a steady and growing stream of policymaker references to the catch-all "IBOR" (inter-bank offer rate) term relative to the increasingly outdated "LIBOR" term.
Significant activity regarding references to €STER is not surprising given the considerable additional architectural elements that require implementation to accelerate the transition away from LIBOR by year-end 2021.
The activity tells us three things about forward-looking policy formation as the last quarter of 2020 quickly approaches.
1. Regulators Are Serious About Increased Oversight
We can expect regulators to increase the regulatory pressure on banks steadily as 2021 approaches. The Bank of England has been sending increasingly tough enforcement signals throughout 2021. But when the Monetary Authority of Singapore joined the chorus this summer, market participants should sit up and take notice:
Regulatory risks and potential fines can be expected across the spectrum, from consumer protection to model risk management. Most importantly, the Bank of England is no longer alone in sending stern regulatory oversight messages.
2. The Financial Sector Is Not Ready
Market participants are accustomed to seeing consultants traffic in fear-mongering with frightful tales of massive IT reconfiguration projects needed between now and the end of 2021. But when the Bank of Japan teams up with the Japanese Financial Services Authority to publish embarrassing readiness data from Japanese banks, it is clear that latent operational risks exist in the global banking system related to the LIBOR transition:
As this passage points out (as well as the MAS passage above), the LIBOR transition is about far more than a simple Y2K code fix. Customers must agree to new contract provisions across a dizzying array of complicated financial instruments and portfolios. This is not just a cut-and-paste initiative that can be easily automated.
More importantly, the lack of readiness in the financial sector suggests that implementation efforts will be rushed. Large scale technology projects rarely function smoothly on Day 1. If over 50% of the Japanese financial sector is planning to deploy technology solutions in the second half of 2021, this does not leave much room for error.
Japan is not alone. Policymakers in London and Frankfurt have been ringing alarm bells regarding lack of preparedness for months.
Scenario analysis designers and strategists should start thinking now about the possibility for systemic disruptions in discrete markets that may not be at the top of the agenda for deployment of advanced technology. They should also start exploring now the possibility of increased regulatory restrictions, requirements and even fines on financial institutions that do not increase the urgency of their LIBOR transition implementation.
3. But At Least the New Benchmarks Performed Relatively Well During the COVID Crisis
Some good news does exist. At least the new benchmarks have weathered the initial COVID-19 storm relatively well. New data from the European Securities and Markets Authority indicates that even the relatively thin €STER markets performed with resilience in early 2020:
The Report also provides helpful charts and graphs that illustrate the market performance of the new benchmark in Europe. So the good news is that even with low adoption rates and low liquidity, the new benchmarks did not add to financial stability risks during a period of major market stress.
More encouragingly, market volumes doubled during the height of the crisis. Now policymakers need to accelerate market transitions from legacy rates to the new market-based benchmark rates.
This shift is not without its own risks, of course. For more information on how to measure and manage LIBOR transition risks, download this free ebook that we published this year.
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