LIBOR Transition constitutes a historic point of reference for the Financial industry. With a deadline quickly approaching (end of 2021), the financial industry’s agenda highlights the transition as one of the most important topics, if not the hottest, with the final outlook on how to pave the way to alternative reference rates looking promising. Yet, for professionals busy with overseeing the transition process, an alarming number of challenges have arisen.
Starting with, introducing the new Risk-Free Rates (RFR’s) becomes a complicated procedure since they exclude a key component in their calculation, the market credit risk. Calculating the market credit risk and including it in any interbank agreements or covenants is a relatively thorough process, but not standard, whereas with LIBOR market credit risk was already included. Therefore, many have turned to regulators and AARC for hearing their expectations and aligning their strategies accordingly.
Turning to regulators for a clearer understanding indicates the need for acquiring a substantial knowledge on the methodologies for calculating RFR/ARR. This is essential as coherence in interbank lending will eliminate SOFR calculation inaccuracies and consequent higher fees in lending, but will also provide the parties involved with a 30-year horizon view in their interactions. Nevertheless, the correct calculation means that legacy loans can also be adjusted in ARRs and communicated properly in a legally shielded method.
The role of technology:
For all the above we can rely on a common factor for addressing them, and no wonder that this is data-powered technology. To elaborate, the use of extensive technology through the correct acquisition, peruse and application of data can most definitely assure the efficient interaction between various actors in an agreement covenant no matter if this is an existing one or a future one.
For this reason, a considerable number of RFR/ARR calculation software have been developed, with an analogous number of solutions now available in the market. Despite this, it is safe to say that without a mutual understanding of the regulators’ expectations, there is still room for left open for the development of such tools. Then, this train of thought can be applied to almost all business segmentations.
However there is an advantage of the modern era that technology can encapsulate, and this is the use of real-time data. With the use of real-time data, obstacles in calculating the lending rates can be overpassed at best since the component of market risk can be easily added in the equation. No need to mention that re-adjustment of legacy loans to the new benchmark rates can be more transparent, therefore helping financial institutions to maintain the levels of trust with their clients while ensuring the product offered keeps its integrity intact.
In any case, the future and its results will showcase any success, challenges, and failures of technology in LIBOR transition.