The three phases of the transition
The transition away from LIBOR consists of three phases:
Phase 1: Contract inventory and review
The first step is to assess the impact of LIBOR on existing contracts. Banks must be able to segregate contracts that reference LIBOR from those that do not. However, this analysis is complex and requires deep domain expertise and understanding of asset classes. For example, a fixed-rate loan contract that is ostensibly not linked to LIBOR may contain an interest rate derivative linked to it. Banks must develop a set of contract review questions that address these complexities.
Phase 2: Pre-replacement rate action items
Although there is no clarity yet on the replacement rate, banks must start now to incorporate interim amendments. For example, if there are loans that do not have any fallback language, banks can incorporate a soft fallback option. Banks can also start to develop contingencies. For example, LIBOR serves seven different maturities (overnight, one week, and 1, 2, 3, 6 and 12 months). However, the replacement rate might not mimic the same tenor structure, so banks can plan for contract changes that should be implemented in this case.
Phase 3: Post-replacement rate action items
Soon, there will be clarity on the replacement rate, its characteristics, and how it will be operationalized for each asset class. In this phase, the bank must amend contracts, update systems and processes to procure and test data feeds for the new rate, and train staff to address the needs of the new rate.