Treasury, Tax and Legal as well as Technology are the main impact areas where Alternative Reference Rates (ARRs), foreseen to replace Interbank Offered Rates (IBORs) soon, could create hiccups for Corporates. Thus, understanding the relevant transition challenges is key for a successful IBOR transition of any affected Swiss-based company. Author: Patrick Arcon
Interbank Offered Rates (IBORs) such as the USD LIBOR or the CHF LIBOR are no longer deemed to be a desirable benchmark and therefore need to be replaced. These (L)IBORs serve as a cornerstone of the financial industry today, and the planned transition away from it will impact a vast array of products, businesses, systems and processes, as well as customers and counterparties, in Switzerland but also on a global scale.
The successful replacement of (L)IBOR by the so called Alternative Reference Rates (ARRs) is expected to be a multi-annual process. The IBOR transition, which has begun with the publication of ARRs in five major currencies (CHF, EUR, GBP, JPY and USD), will be wide-ranging and significant for all kinds of financial activity.
For Switzerland, the Swiss Average Rate Overnight (SARON) has been selected in October 2017 to be the replacement rate for CHF LIBOR. The new rate is administered by SIX Swiss Exchange, is based on transactions and binding quotes from the CHF interbank overnight repo market. SARON is seen as the most reliable rate to be used for CHF derivatives and other financial contracts.
Recently, the European Exchange (Eurex) announced that they will start trading 3-month SARON futures starting end of October 2018. The launch of SARON futures is an important step in the transition from CHF LIBOR towards SARON.
Several major transition challenges for corporates
(L)IBOR change is going to affect virtually every company dealing with these rates. The effects are significant and will influence broad parts of the organization as these rates are pertinent to the business of any firm facing market value exposure to Interbank Offered Rates in its normal day-to-day job.
We have identified the following three key potential transition challenges to be aware of:
Financing and hedging strategies:
- A Change in reference and benchmark rates will require changes in the financing and hedging strategies.
- If not considered early enough, increased costs and negative income effects can arise (mainly due to ineffective hedge relations).
(L)IBOR based contracts and contract clauses:
- The inventory of “(L)IBOR-based” contracts and contracts with (L)IBOR clauses are vast and not only related to treasury or finance (e.g., early payment clauses in purchasing contracts), but the awareness thereof is still limited.
- A Non-timely adaption of this change is considered a high risk.
- If treasury and treasury-related systems capturing market data and financial products will not be adapted in time, substantial manual workarounds will be required. Consequently, a lack of control and increased risks might occur.
The new/alternative reference rates will not only differentiate from existing (L)IBORs in the way they are calculated; they will also defer in their logic and concept. This will lead to material changes in processes and procedures. For instance, SARON is an overnight rate and currently does not have the same range of tenors as the CHF LIBOR. In addition, SARON is a secured rate and therefore does not include any credit spreads.
Main impact areas for corporates
To sum up, we conclude that several key impact areas of Swiss-based companies will be affected by this change:
- A Change in pricing methods for banking products (derivatives, cash pools, etc.) is leading to substantial impacts on valuations, intercompany pricing, etc.
- Hedging strategies or hedge accounting approaches will be challenged; therefore, several impacts on legacy hedges (i.e. futures contracts that are common in the commodity industry) are to be considered.
- Funding strategies uncertain with regards to variable financing based on IBOR having impact on an organization’s asset and liability management.
- Supplier financing contracts and working capital programs will have to be re-negotiated and re-priced.
Tax and Legal:
- All contracts related to IBOR rates are affected and will have to be re-negotiated (e.g. Master Agreements by the International Swaps and Derivative Association, Credit Support Annexes, cash pooling contracts, early payment clauses in client contracts, etc.).
- Transfer pricing documentation needs to be updated whenever a reference is made to IBOR rates.
- All advance tax rulings that are addressing intra-group financing transactions will have to be amended.
- The book value of debt instruments and certain other assets and liabilities may potentially change – thus, there will be an impact on current and deferred taxes incl. a correct distinction between P/L and Equity (OCI).
- The incorporation of new and adjusted products into treasury and treasury related systems will be necessary.
- Platforms, confirmation matching tools, market data providers will have to be updated.
- New interest rate (curves) required next to the “legacy” (L)IBOR curves are required, thus impacting current valuation models and interest calculations of financial instruments. Technical “novation” of existing (L)IBOR based trades will have to be considered.
- Adjustments on interfaces such as market data feeds will be required.
Consequently, EY has developed a dedicated concept for all affected Swiss-based companies to better overcome potential upcoming challenges when changing from (L)IBOR to ARRs.