Banks face $10 trillion benchmark rate change, as COVID-19 hits loan books

The banking sector confronts another huge task in the year ahead as it transitions $10 trillion of financial products to new global reference rates.

Ashurst’s global head of finance, funds and restructuring Jamie Ng. Picture: Adam Yip

Australia’s banking sector confronts another huge task in the year ahead as it transitions $10 trillion of financial products to new global reference rates, while also grappling with swelling COVID-19 loan losses.

Ashurst finance partner Jamie Ng said the shift away from benchmarks including the London Interbank Offered Rate was among the most significant challenges to affect financial markets in the past 20 years.

“It’s huge, it’s a really complex undertaking across multiple facets of the organisation,” he said.

“It’s pervasive, it affects a multitude of different products and it affects a multitude of different types of counterparties.”

Mr Ng, Ashurst’s global head of finance, funds and restructuring, said the backdrop of COVID-19 and the magnitude of the amounts involved meant managing an orderly transition to new risk-free and alternative reference rates was important.

In April, Britain’s central bank and Financial Conduct Authority stuck to a final deadline for the Libor transition to occur at the end of 2021. But in light of COVID-19, an extension to the first quarter next year was allowed for loan changeovers that had been due in the third quarter 2020.

The overhaul comes after the Libor benchmark was the subject of a rigging scandal that was mirrored in Australia, where local regulators in 2017-18 took on the big four banks over allegations they manipulated the bank bill swap rate. Three of the big four banks settled with the Australian Securities & Investments Commission on the matter, while Westpac was found by the Federal Court to have engaged in unconscionable conduct but not market manipulation.

Benchmark and reference rates are used for pricing a spate of products and bank funding including loans, bonds, derivatives, securitisation issuance, and trade finance facilities. That means the move away from Libor and other benchmarks will affect businesses and other bank counterparties.

Mr Ng said banks were having to closely assess existing portfolios to amend contract terms and also look at how they structured and tested new products.

“What you want to do may be simple enough. The risks get magnified because of the volumes of them sitting on the book,” he said.

“Another thing that all banks have really focused on is conduct risk and that goes to shape their overall strategies.”

The BBSW has been the subject of a reform process; its administration was transferred to the Australian Securities Exchange in 2017 from the Australian Financial Markets Association.

Reserve Bank assistant governor Christopher Kent in April urged local institutions using Libor to “act now to transition to more robust benchmarks” in a timely way.

“Use of Libor beyond the end of 2021 poses significant reputational, operational and legal risks for institutions. It also risks disruptions to financial markets,” he said.

Institutions that responded to a letter last year from the corporate regulator have been separately provided with feedback from it and the Australian Prudential Regulation Authority on transition preparations.

Regulators estimate the Libor exposure of Australian financial institutions is $10 trillion, with 40 per cent to mature after the end of 2021.

“We continue to actively work with our customers, regulators and industry participants over the course of the transition,” said Drew Bradford, National Australia Bank’s markets, corporate and institutional banking executive.

“NAB is well-progressed in our planning to transition away from Libor to alternative reference rates by the global target date.”

Macquarie Group published a document in April that said the shift involved “fundamental changes” in market behaviours and conventions, and the company was progressing an internal project.

The document listed key risks linked to the transition away from Libor, such as contracts not functioning properly, and differences in accounting treatment if cash products and derivatives were misaligned.

Mr Ng said some financial institutions were testing new products and systems to comply with the Libor changeover several months ahead of the Decembe 31, 2021, deadline.

“The scale of this market event is enormous and entails multiple issues, risks and challenges,” he said, adding that the transition was similar to significant changes in anti-money laundering laws in 2006-07.

Commonwealth Bank and Westpac have, though, been taken to task by the financial crimes regulator for failing to comply with that regime.

On the upcoming benchmark rate changes, Westpac has set up a group-wide program to coordinate global efforts and meet the regulatory timelines.

“Westpac has advised its regulators on the establishment and progress of the program and will continue to provide regulatory progress reports throughout the IBOR transition period,” a spokesman said.

CBA’s website cites “ongoing initiatives and actions” to manage the transition for the bank and its customers.

An ANZ spokesman said the bank’s project team - in place since mid-2019 - was helping to prepare it and customers for the transition to new and alternative rates.