SOME bankers would consider adjustments to the phaseout of Libor less a labor of love, as the end of the 34-year-old financial tool brings additional tasks the sector must undertake.
“The most important number in finance will disappear in 2021,” lawyer Russell Stanley Geronimo wrote in an opinion piece for the BusinessMirror. (See, “Is the Philippines ready for the 2021 Libor phaseout?” August 17, 2020) “The London Interbank Offer Rate (Libor), which is an interbank interest rate at which banks on the London money market are willing to lend to one another, will soon be phased out.”
By 2022, the banking industry will be introduced to a new benchmark for borrowing costs.
Analysts emphasized that a well-oiled transition to new metrics—a significant undertaking for fund managers and bank officials—is key to avoid major disruptions in the financial sector.
“The transition is a complex undertaking that will require serious attention and efforts to execute,” Fitch Ratings director for APAC-Banks Willie Tanoto told the BusinessMirror.
As Geronimo had explained, “the benchmark administrator will cease publishing the rate, meaning it will no longer appear on the Bloomberg or Reuters screen.”
“This has a significant impact in the financial markets.”
Transition ‘manageable’
NONETHELESS, S&P Global Ratings Analyst Nikita Anand told this newspaper the Philippine financial system may not find it too difficult to adapt to a post-Libor era because of its low exposures on Libor-linked instruments.
“For the Philippines specifically, we envisage the impact to be manageable, given Libor-linked exposures are not significant and peso-denominated loans are linked to domestic benchmark rates,” she explained.
Anand noted, however, that transitioning to new benchmark rates was put into the backburner in the region this year following the disruptions brought about by the Covid-19 pandemic. Still, she said, the banks in Singapore and Hong Kong have been leading the move.
But the S&P analyst said that both regulators and banks would eventually accelerate their transition efforts as end-2021 draws nearer.
“Banks’ ability to handle the transition to an alternative benchmark while maintaining profitability margins and asset-liability management thresholds will be key,” she said.
Year post-2021
RIZAL Commercial Banking Corp. (RCBC) Chief Economist Michael L. Ricafort said that the local banking industry, along with the global financial sector, has been preparing for the imminent transition in recent years.
Should the transition go accordingly, the RCBC economist said that the impact would be “minimal.”
Ricafort said there will still be adjustments, especially from a legal aspect. He said that Libor-priced borrowings and other funding contracts, along with future transactions, will be needing revisions.
According to Geronimo, “the notional value of debt instruments and financial derivatives referencing the Libor is estimated at $360 trillion worldwide.”
He added that in the Philippines, Libor “is referenced in syndicated loan agreements, subordinated indebtures, promissory notes, credit facility agreements, surety bonds, floating rate notes, treasury bonds, forex [foreign exchange] forwards and forex swaps.”
Geronimo, who is a banking, finance and securities lawyer at SyCip Salazar Hernandez & Gatmaitan, added that “some of these existing financial products have terms extending beyond 2021.”
Judgment of data
SO far, the industry is looking at the Secured Overnight Financing Rate (SOFR) to replace the LIBOR, which sets interest rates at which banks borrow from each other.
While both cover short-term borrowing costs, the SOFR is based on daily transaction data while Libor is based “partially on market-data ‘expert judgment,’” according to Morgan Stanley Research. It added that the SOFR provides a daily rate while Libor has seven varying rates with terms ranging from one day to one year.
“SOFR is the widely expected and emerging alternative to the phasing out of the Libor as a benchmark for pricing loans and deposits, although there are also other choices being considered in other parts of the world,” Ricafort explained.
Contracts review
BUT while the local banking system is expected to transition smoothly to a SOFR, a thorough review of the current contract portfolio is needed, Tanoto said.
He said banks should be able to identify which are the ones pegged to LIBOR to help them measure and manage exposures.
“In addition, a host of systems and procedures need to be in place, from updated loan and trading systems and software, administrative and accounting systems, risk management modelling adjustments, updated legal procedures, regulatory reporting, internal staff training, external customer education and so on,” he said.
“There is a lot of work involved, the requirements may shift during the course of the transition and not all of the problems have ready solutions until the SOFR market matures and new standards get established,” he added.
Products, pricing
NOW, the question is, what transactions will be affected by the transition? The short answer is, all Libor-linked instruments. To be more specific, Tanoto identified the most common transactions.
The Fitch Ratings analyst said that the majority of the LIBOR instruments in the Philippines are dollar-denominated. These include bilateral and syndicated loans, trade finance products, floating rate notes, interest rate swaps and cross currency swaps.
“Foreign currency loans amount to $18.3B at end-March, which is just under nine percent of total system loans; much of this is likely to be indexed to USD [US dollar] Libor,” Tanoto added.
He explained that the Philippine Interbank Reference Rate (PIFR) will also be affected because it is based on the foreign exchange swap market—and Libor is primarily used in pricing the instruments. In a way, this can also affect domestic peso interest rates, he added.
“Foreign currency exposures and derivative contracts will be most affected, as they are typically Libor-linked and banks will have to review, amend contracts and update systems and processes for the transition,” Anand said.
Impact on bond market
THE bond market appears to have foresight on the matter.
Ricafort and Tanoto said that the transition to a new benchmark interest has only minimal impact on the bonds.
The RCBC economist said that bond prices and yields have been largely priced at spread over relevant benchmark bonds, including those of US government bonds or treasuries.
“The bond markets have evolved based on actual transactions in the market (i.e. based on actual purchases and sales of bonds in both the primary and secondary market),” Ricafort explained.
Recently, local companies have been participating in the offshore bond market, launching dollar-denominated offerings.
Yuchengco-led RCBC, for example, recently debuted its $300-million offshore bond offering, and its orderbook reached as much as $825 million. The proceeds of the offering are allocated to finance asset growth and other general corporate matters and to maintain enough reserves above the minimum requirements by the Bangko Sentral ng Pilipinas.
Filinvest Development Corp., meanwhile, announced this month that it was planning to offer and issue dollar-denominated senior unsecured notes.
Proceeds are earmarked to refinance the company’s financial obligations and fund its investments in digitalization, renewable energy, water, desalination and wastewater, district cooling and other infrastructure projects.
A better tool?
RICAFORT stressed that Libor has played a significant role in pricing financial instruments. Libor, he said, has been used as benchmark for pricing loans and deposits, especially those denominated in US dollars and in other major global currencies.
Still, he said, this benchmark has its flaws, hinting that transitioning to SOFR might be a better choice.
“It is important that the next benchmark truly reflects the true cost of funding in US dollar and in other major global currencies that will be widely expected by global banks/financial institutions and regulators, and also not subject to manipulation, as seen in cases in the past involving Libor,” Ricafort explained.
‘Premature’ to compare
TANOTO, meanwhile, is holding off judgment. He said that choosing which one is better depends on the situation at hand, although he agreed with Ricafort in saying Libor is indeed vulnerable for manipulation.
“For instance, one of the motivations for moving away from Libor is to prevent banker manipulation of the Libor fix; and SOFR does seem to achieve this, since it is much harder to manipulate such a vast market,” he said. “However, it also means that the rate is subject to the day-to-day volatility of real-world transactions.”
The Fitch Ratings analyst said that it might still be “premature” to compare the “budding new benchmark with a market convention that has dominated global finance for half a century.”
The banking industry has yet to see how the SOFR matures along with the market.
Image credits: Wirestock | Dreamstime.com