Much has already been written about the impending phase-out of the Interbank Offered Rates (IBOR), which includes the prevalent London Interbank Offered Rate (LIBOR). The financial services industry is well aware of the challenges presented by IBOR cessation. Institutions are attempting to tackle the challenge of assessing their IBOR exposure in existing contracts and the need for remediation to the impacted transactions that will not expire prior to the end of 2021. Other challenges that the industry will encounter include creating products that employ new alternative reference rates, effective customer outreach, and system updates to reflect the new rate structures. We see institutions are heeding the regulators’ warnings and making strides in establishing internal governance structures and building transition strategies.
The IBOR phaseout is estimated to impact over $350 trillion worth of contracts. As noted, financial institutions and companies with IBOR-related transactions must review every aspect of their business that depends on any of the IBOR Benchmark Rates. Risk management and remediation are often time-consuming and costly, posing key challenges during the review process, however, those processes will be crucial in the transition away from IBOR Benchmark Rates.
Contractual Documents in the IBOR Equation
Financial institutions need to understand their contract landscape in order to begin segregating contracts based upon factors such as expiration date, rate tenor, as well as potential rate adjustment or fallback language.
The goal will be to segregate or triage existing contracts for risk prioritization review.
Triaging the contracts into like groups will serve to streamline the remediation workflow. This process requires detailed planning and understanding of the various impacted lines of business. For example, we have encountered contracts that do not include a specific IBOR Benchmark Rate reference but are related to an underlying IBOR Benchmark Rate transaction. These contracts are important in the review because they often contain critical rate adjustment provisions that can impact the decision of how to remediate. Consequently, the success of an IBOR remediation workflow plan depends on an ability to clearly identify and understand the nature and scope of the impacted contract landscape, and the ability to efficiently take the steps needed to transition away from IBOR Benchmark Rates. Organizations will be able to minimize risks and challenges through an established and clearly defined remediation program.
Contract analytics in a well-managed transition
Contract analytics solutions, particularly those that employ advanced Artificial Intelligence (AI), accelerate contract review and remediation efforts of critical financial transactions. By identifying legal documents based on the presence of IBOR-related terms, these platforms can deliver insight and automation to streamline the IBOR review process. Best-of-breed contract analytics solutions can identify and extract key IBOR-related topics from a wide range of financial transactions, including commercial credit agreements, derivatives, and trading instruments, mortgages, and bonds. They make it possible to recognize variance in standard contracting language, a capability that not only expedites the triage process but also feeds directly into automated decision-making regarding replacement documents.
The most effective AI tool for IBOR remediation will exhibit a deep understanding of the key issues of concern and employ contract analytics for the IBOR remediation analysis. The tool must also be flexible to incorporate new guidance as it becomes available, such as the ARRC or ISDA fallback language provisions. Further, tool flexibility will be a critical component in the inevitable litigation and need for conflict resolution.
Risk and opportunity on the horizon
While the phaseout of IBOR Benchmark Rates is clearly on the horizon, uncertainty remains regarding the use and effectiveness of the proposed Alternative Reference Rates. Even though the future of the rates and the related cost implications may remain unknown for some time, institutions have the opportunity to get ahead of the curve with a well-structured contract landscape review.
It is mission-critical to build actionable insight from the data made available in the IBOR phaseout to minimize risk and maximize revenue. A smooth process and one that avoids litigation or costly administrative burdens will provide insight into contracts and lend certainty to the shift that lies ahead. Further, the work done today will better position the institution for the next regulatory shift. After years of working in regulated industries, we can be certain that there is always another shift on the horizon.
For more on how financial services professionals can prepare for the transition away from LIBOR, listen to the on-demand webinar.
If you are interested in learning how Seal can support your risk management and remediation process, download our LIBOR Insight™ datasheet today.