Phasing out Libor & Potential Impact on Supply Chain Finance Programs

The U.K. Financial Conduct Authority (FCA) announced in July that LIBOR will be phased out by year end 2021. According to a recent report by Kroll Bond Agency, this will have far reaching implications across the credit markets as many derivative contracts, corporate bonds, syndicated loans, mortgages, and securitizations reference this benchmark.

So how does this impact Supply Chain Finance? Many banks that offer supply chain finance to large corporates use Libor as a base rate to calculate spread the banks charge.   By changing the base rate, all contracts will be open up for renegotiation. This will have huge implications that have yet to be thought through. Think about the operational processes involved.

Sure you can use a different base rate. As the Kroll reports says, the Fed convened the Alternative Reference Rates Committee (ARRC) in late 2014 to identify a set of alternative U.S. dollar reference interest rates and to determine an adoption plan for their use. In June 2017, ARRC recommend a broad Treasuries repo rate, now called the Secured Overnight Financing Rate (SOFR), which is the cost of overnight loans that use U.S. government securities as collateral.

SOFR may not be the most applicable rate for supply chain finance for at least two reasons:

  • First, SOFR is essentially a risk-free rate, as it is based on transactions secured by US government securities, whereas LIBOR is more closely aligned to a bank’s cost of funds
  • Second, SOFR is an overnight rate, while LIBOR is forward looking term rate (i.e. 1 month, 3 months, 6 months, and 1 year)

Today, if your Supply chain finance agreements references Libor, you have to make companies physically resign millions of documents. As the Kroll report states, the impact on legacy securitizations could be much more problematic, particularly where the transaction documentation did not contemplate an alternative benchmark.

With Libor set to be phased out in 2021, it may not be enough time. The paperwork is extraordinary. It takes months to renegotiate lending contracts. To be replaced in 4 years, the implementation needs to be thought through soon. I dont hear many talking about the operational work involved. This is a huge operations process. One expert I spoke to thinks it could take a decade, at enormous costs to the banks.

For a market that is approaching $500bn globally in size, it’s a significant challenge.

I plan on doing some research here to better understand what banks are doing, and if you are a bank involved in supply chain finance and would like to chat, you can reach me at dgustin@globalbanking.com

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