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With the impending demise of the longstanding key interest rate index, millions of adjustable rate contracts need to be revised. Here’s how to turn a logistical headache into an opportunity for modernization.
With less than two years to go, financial institutions and corporate treasuries are preparing for a world without LIBOR. The biggest task: modifying client and counterparty contracts, a process known as repapering.
Set to expire at the end of 2021, the London Interbank Offered Rate (LIBOR) has long been the dominant benchmark interest rate for adjustable rate financial products. The majority of LIBOR transactions are derivatives, but with millions of corporate loans and home mortgages also indexed to LIBOR (for a total of $350 trillion), its demise will be widely felt across industries.
Nowhere will the impact be greater than financial institutions and corporate treasuries, which have to repaper and renegotiate millions of contracts that expire after 2021 and index LIBOR with no risk-free rate (RFR) fallback language.
Repapering is complex and involves multiple steps, from impacted contracts and language identification, to final agreement with clients and counterparties. Regardless of their size, organizations face substantial work ahead. Here’s a clear path to getting started and succeeding in the repapering process:
Many financial institutions don’t have an inventory of their contracts, or even a close estimate of the number of contracts. Taking stock of where contracts sit within the organization, how many there are and the form in which they’re stored is a key initial step for repapering. How many are paper-based? How many are digitized?
Many institutions expect to create ad hoc AI engines to fully digitize OCR’d contracts with the relevant meta data. But machine-learning algorithms need time to be trained. The richer the metadata, the fewer exceptions and the less rework.
Some progress is being made. The Alternative Reference Rates Committee (ARRC) – the U.S. working group tasked with identifying a new reference interest rate and fallback language – has extended the feedback period for adjustable rate mortgages and published clarifications last August for floating rate note (FRN) transactions.
For its part, the International Swaps and Derivatives Association (ISDA) recently released a consultation on final parameters for fallback language and computations on derivatives, expected to be finalized for implementation in 2020.
Perhaps because of the slow pace of decisions – not to mention the tremendous scope of the migration effort – we see a lot of organizational procrastination when it comes to LIBOR-related language remediation.
Even with the year-end results, these overall recommendations will not fit all situations and should push organizations to develop solutions that combine AI and rules-based systems, and plan for remediation.
Once processes, roles and responsibilities are defined, LIBOR program execution can begin, enabled around these key functions:
While LIBOR phase-out is a logistical headache, it also represents a window of opportunity: Modernizing contract processes that are fragmented and outdated is an important advance for every organization. What’s more, advanced contract management solutions can help serve other purposes, such as the requirements for qualified financial contracts (QFCs), know your customer (KYC) and client onboarding.
Now is the time to convert the countdown to LIBOR into an opportunity.
For more information, please visit https://www.cognizant.com/libor-transition-solutions.
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