Corporate Treasury LIBOR transition
In this call, senior treasurers from seven MNCs in Europe and the U.S.A discussed their LIBOR transition projects. This report details their approaches to transition, the current status of their projects and their concerns.
Call date: 17th Jan 2021
The call was expert chaired by Damian Glendinning, whose commentary appears below.
This report was produced by Monie Lindsey. The full report appears below.
What follows is a very detailed summary of a discussion which was surprisingly animated, given the subject. The main points:
Bottom line: disappointingly, and though many issues have been resolved, we still do not have agreement on all the details – and we all know where the devil resides. The biggest issue is how the average historical rate will be calculated, and how the lookback it implies will be handled. This means that the TMS providers are not able to provide the required systems updates. Participants confirm that it can impact a surprising number of areas in the company, and there are concerns about potential tax issues on intercompany pricing – we should not use the extended publication of LIBOR to delay implementation.
So it is important to keep close to this, not delay, and do everything we can to be prepared.
Topics addressed in this discussion
Seven companies were represented in this call comprising multinational companies with headquarters in Europe and the United States. On average they have operations in 75 countries and employ 48,000 people.
Comment: The real question at the end of the day, in my mind, is what is the financial impact going to be? I mean, how I understand it is that you may end up with a couple of basis points difference in what we go to, whatever that ends up being. But how big a deal is that?
Response: You sound just like my boss. That’s his only question. How much is it going to cost him? We’re being told, (from the lawyers and the bank’s lawyers), that it won’t be a significant change in interest rate, spread and payment. But nobody has solid figures for us yet.
Comment: In many ways the interpolation of LIBOR was good because it reduced volatility. I mean, the biggest issue I see here is that if you end up with no smoothing taking place, you’re likely to end up with significant volatility.
Response: Yes, that’s true.
Comment: But again, I don’t know. Because remember one of the funny things in LIBOR, if you look at the initials, it’s the London Interbank Offered Rate. How can this exist when the banks are not lending each other money? They stopped lending each other money years ago.
Response: Yes. And it’s just got so much steam now that it’s basically happening. There’s not a whole lot we can do about it.
Comment: You’ve introduced something I hadn’t thought of, which is if you’ve got intercompany loans, you need a new reference rate: presumably your concern is that there’s going to be potential for tax authorities to query whatever rate you use. LIBOR was universally accepted. Now we will have a series of different benchmarks.
Response: Yes. There are a lot of international companies on the line with LIBOR in every one of our contracts. Now, we’re not completely sure what we do, when it’s between companies that are not based in the US, are we using SOFR or what are we supposed to use? It’s up in the air right now.
Question: Do you think this is a serious concern, that this is going to lead to a rejection by tax authorities?
Response: Well, our tax director is concerned about that. But he doesn’t have enough details to know for sure if the risk is real, or if there’s something we really have to prepare for. I was hoping somebody else was further down the road to help me on that.
Question: Presumably, from the point of view of the TMS manager, what’s required is the ability to plug into a new rate. I’m assuming that once it’s published by somebody like Bloomberg and others, that shouldn’t be too big an issue. The only problem is they need to know what it is.
Response: Yeah, and I think for the bigger TMS providers, that’s not a big problem. However, for some of the smaller ones, it is taking more to get them to understand that this is coming their way. It’s quite surprising the amount of people I’ve spoken to from smaller TMS providers who really weren’t sure that this was something that had to be done this year. So, I don’t think it’s apparent enough to everyone involved.
Question: Which TMS provider do you use?
Response: Bellin who has just been acquired by Coupa in the US. Fortunately, they have a presence in Europe and the US and are all over this change. I’m not worried about them particularly.
Question from ONE: So do you think we’ll be using a range of rates? If my cash management bank will not accept LIBOR, do you think it’s going to be a combination of rates?
Response: So, if we think about LIBOR or IBOR right, interbank offering rates and LIBOR is not the only one. In terms of what is disappearing for LIBOR, it is USD, GBP, CHF, JPY and EUR. Those LIBORs are going to disappear. But EURIBOR or TIBOR (Tokyo Interbank Offer Rate), are straightening out their methodologies. And then if you think about AUD, BRL CAD HKD, MXN, NZD, the IBOR to IBOR is going to coexist with risk free rate. So they’re different places where different things are happening. I know we are all focused on USD or GBP. And we talk about LIBOR. But there are other things with other countries as well.
In terms of intercompany, we have ARRC, which understands that intercompany is important. The whole idea of ARRC was that if our analysis of intercompany under LIBOR and subsequently with the new rates, is backed by ARRC, it will provide us with a good background for discussions with tax authorities. However, I think we will be addressing intercompany much later in the process. First, we are going to make sure that the USD LIBOR is replaced by SOFR and SOFR is available when you want to make the transition.
Question: Can I ask you the question that in value terms, what’s the difference between LIBOR and SOFR?
Response: SOFR is a standard offering, overnight fixed rate. So it is a real rate that is being used. It’s a tangible rate, whereas LIBOR was not exactly an offering rate. I think the discussion about whether LIBOR will be replaced or not is a done deal – that ship has sailed. We just have to adjust GBP for GBP SONIA and USD for USD SOFR. The two year extension was given but I think Fannie Mae and Freddie Mac are going to start issuing loans with SOFR.
Comment: They started issuing funding earlier. So the question is today if you compare the two rates, are they different?
Response: Yes, they are different. And we (a team including corporates led by ISDA) spent a lot of time to come up with an agreed spread when we do a one-time shift from LIBOR to SOFR.
Question: Is there more volatility?
Response: I don’t have the numbers or benchmarking. But there should be less volatility, because SOFR is a more tangible rate. There have been situations where, as you mentioned in the financial crisis, where it has gone up. To address that volatility, the idea is to use the one month average, rather than each day’s average or something similar. There’s a lot of work being done on that as well – whether you have a LIBOR or SOFR based contract for one month, do we use the last day, or the average of all the SOFR rates for the whole month? So that will reduce the volatility.
Comment: Okay, so that discussion is still taking place.
Response: I think it’s taking place and I understand SONIA is ahead of us and has made some decisions on the averaging method. Even within the averaging method, there are two ways to do it – simple averaging versus daily compounding. From what I understand, people are leaning towards daily compounding.
Comment: Ok… one of the risks here is that you could end up with multiple benchmarks for the same currencies.
Response: No, I don’t think so. I think there will be a transition period where LIBOR and SOFR may coexist, but that’s because of the two year extension. As discussed, some TMS providers didn’t even know they needed to make any changes. So that’s why they gave another two years. But after that, there’s going to be only one rate going forward and that’s going to be SOFR for US and SONIA for GBP.
Comment: Okay, so one rate per currency. Now, can you help educate me regarding the TMS providers. I understand this means that they need to go into whichever data provider you’re using and pull the rates. Is it that difficult to go and pull a different rate?
Response: No, it should not be. Auto rates are available. The Fed is going to make SOFR available – it is already available. The Fed is going to be the administrator of SOFR.
Question: Why does it take the TMS providers a year to do this?
Response: Large TMS providers are already working on it. Still, the devil is in the detail. It’s not just adjusting the software. Because SOFR is a look back, it has been decided that an averaging method is to be used which generates multiple additional methodology questions:
Question: Okay, I assumed that the average would be done by whoever is publishing the benchmark and you just let the rate that comes out of that go.
Response: There are complications there, because you want to come up with a rate which is based on average, then you need time to do that averaging – next day, two days? And then whoever comes up with the rate, then you have to give two or three days for the borrower to make that payment.
And then do we wait? Do we look at a lock out period and a look back period? Should it be exactly the same period? Should it be staggered by two days so we get more time to calculate the rate? Those are all the things that people are going to face. Do we really understand how we are going to do that? And, averaging is not as simple as it sounds. It could be simple averaging. But many will say no, daily compounding should be used for everything.
Comment: I’m impressed by how we managed to make this complicated.
Response: It’s that so many trillions of dollars are involved. So people are looking at it, especially ARRC and GBP authorities. They want to make sure that it’s bulletproof. It’s not as simple as you would first think.
Comment: I understand that this is very important for the banks, because the banks do have the trillions, and because there is the potential to create mismatches within the banks. But from the corporate point of view, I suppose I’m not particularly sympathetic to the tax issues on this.
Response: I think from a corporate perspective, we need to understand what is going on. And then we need to advocate for our own rights, just like the credit spread was considered very seriously on top of the basis points spread between SOFR and LIBOR. And if corporates had been involved, that would have passed through. So corporates have to be very agile and advocate. To their credit, they created ARRC which has many corporate participants. We need to be vocal and to participate to convey our views. Otherwise, the banks could take over and everything will be in favour of banks and not in favour of corporates.
Corporates have to take action. We cannot just sit back and let things happen
Response from ONE: Just, you know, we have been working throughout not only with the TMS providers, but AP and various other vendors that somehow need the supply or change information fed from them as well. So it’s a very big project in the US. And it’s bigger than I even anticipated when we first started, but there’s a lot to it. And I think it has been said so well (by TWO) , that corporates just have to advocate for themselves because it definitely will come back on us and cost as if we don’t make the best decisions now that we can.
Comment: Yes, and they all need to make sure that the banks don’t use this as an opportunity to widen the spreads.
Response: So I think that spread is now pretty much a done deal for SOFR. The credit spread is gone – it is not on the table anymore. Now I think more discussion is on calculations and look back period, etc.
Question: Where would you say the project is from your company’s perspective? Are you still much the same as ONE in terms of waiting for things to be agreed before you can move ahead?
Response: There are three streams that we have created:
Question: From each of those perspectives, how confident are you? Is it just a walk through or are there some serious roadblocks ahead?
Response: So there are no serious roadblocks ahead. I think exposure identification is the most important and is like a pyramid. So at the base of the pyramid, you have to scan through and make sure that you are aware of all the exposures, internal and external contracts you have. Currently we’re waiting for the fallback language. I think ISDA has already issued some fallback language which will become a standard.
People have slowed down, because we have another two years. The urgency has lessened.
Comment: Except, of course, the problem is that that probably means that in two years’ time, people will still be working on this, right?
Response: Yes, that’s what we tried to tell everybody. This was done, because even though we knew about these things three to four years back, still we came to the place of getting within one year and we had to push it back. We cannot be in the same situation again after two years.
Question: To come back to hedge accounting, the one exposure I see is if the two sides of the equation are affected differently. Is that possible under this environment?
Response: It should not be possible. If LIBOR is your benchmark rate for your floating rate loan and the benchmark rate for your derivative you use to hedge it, both of those LIBORs will change to SOFR. We are working with the authorities to make sure that level is replaced by SOFR plus x basis points which is the same for both the loan as well as for the derivative. In that case, both sides of the equation should be equally impacted. .
Question: Is there any potential for all of this averaging to create mismatches?
Response: That’s exactly where the devil is in the detail. So we want to make sure that we understand the ISDA protocol and use exactly the same ISDA protocol for our loans. So for the existing derivatives, you’re not creating any mismatches. This is the biggest place where corporate treasurers and Treasury teams need to be aware and ahead of the curve to make sure that whatever we change on the ISDA side is the exact same thing on the loan side. And that’s why the averaging method and payment date, look back period, lockout period, and then accounting convention and all those things matter a lot, because it could create small mismatches.
Question: I understand the tax authorities challenging intercompany interest rates. But as I think you pointed out that’s happening anyway. This is just going to give them an additional area to challenge you on. Is that right?
Response: Yes, the different interest rates that we would charge our subsidiaries will be coming from our TMS system. So they could potentially say that no, this is subjective. Why did you pay this amount? Explain exactly how this was calculated; show me all the supporting documents, all the reference rates etc.? I’m not saying that that’s going to be the case. But I have concerns.
Comment: That’s the case anyway. I mean, you get the other side, which if you’re looking at it from the point of view of the country where the interest is being paid. They’re challenging the validity, of course, then asking if you’re actually challenging enough, given the credit risk of this happening anyway.
Response: Exactly. You have tax support – does that mean they would argue in the opposite direction? So definitely, of course, it’s a two front war, so to speak.
Comment: I have actually heard them argue that, in fact, what you’re doing is you’re giving a disguised corporate guarantee to the subsidiary and you should be charging for that.
Response: That’s something that we don’t usually do or never actually do. So from that point of view, it’s okay.
Comment: In the lending country, I have heard the tax authorities say, well, actually, you must be charging for it. And we’re going to deem the interest income – but we digress…
Response: And of course that’s within this topic. And they have the new OECD guidelines. And then, of course, tax authorities around the world have views on the capital structure of legal entities and what should be a suitable capital structure in order for us to pay this amount of interest. Then you add complexity. And it’s coming. So it’s an intercompany lending and borrowing issue.
We have external borrowing, and a revolving credit facility, which is quoted off LIBOR. So we have our work stream on that. Additionally:
All of these different units I mentioned have different units within the unit. What I’ve been doing is advocating that this is something that is coming, and they need to prepare for it. It’s not going to be a one man show. I’m not going to do all the work. I am urging them to prepare their different teams to evaluate existing contracts and transactions, keep a close eye on what’s going on in the markets and how this transition works. And then of course, to work with all the stakeholders, which in some cases will include the bank. It’s all about sequence.
I’ve also tried to reach out to areas outside of treasury and customer finance. If you have standard agreements or comments in your contract that say if you pay late, it’s going to be at LIBOR plus, etc., then fallback language is required. If you don’t have it already, put it in for agreement with customers indicating that the new rate will be applied.
From my part, I think what THREE discussed is quite familiar to us. I recognise a lot of the same issues and the same discussions are taking place. I don’t think I need to go into all those details once again.
Response: Yes, that’s true. Now, I don’t know when we use the short term rate. I think most of the time people use a one month lag or a 90 day lever.
Comment: I agree
Response: That’s a good point. I think that was primarily done because the systems were not ready to adopt. Most of them were for one month and 90 days.
Comment: But it does reinforce the point that this is the deadline that we’ve all known about for a long time. And, generally, I think we’d have to say that the finance community, including the banks and regulators, have not got to where we would like to be.
Response: Yes, that’s one of the things we’re noticing. The banks are obviously getting involved early on and we’re starting to see some communication from banks on disparate contracts around the rate agreements. But we’ve also noticed that the banks have possibly been kicking the can down the road a bit themselves, just without having futures pricing on SOFR. I feel like they’re waiting before deciding on the best method, or the best rate or contract language to use in agreements. I’d be curious to know if that’s everybody else’s position as well, if that’s what everybody else is recognising and what they’re seeing in their banking partner content.
Comment: The biggest surprise to me is that I’ve seen banking contracts issued recently still only referencing LIBOR.
Response: Yes, that’s what I’m talking about. I think they’re still waiting to decide or figure out what the best alternative would be.
Comment: I do understand the problems that the TMS providers have, ‘we can’t cater for the change until you tell us what it is’.
Poll: How would you rank your LIBOR project from both a hassle and a risk perspective
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