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Alternative Benchmarks for the New Normal

By Eiichiro Yanagawa

 Latest Trends in LIBOR Transitions in Japan

Once referred to as the world’s most important number, the London Interbank Offered Rate (LIBOR) is the most important global benchmark for interest rates and is referenced in setting prices on derivatives, bonds, business loans, and consumer financial products.

The LIBOR figure has played a crucial role in the financial ecosystem, with more than 240 trillion dollars in financial products referencing it.

A series of problems with LIBOR prompted world regulatory authorities to announce the phasing out of the reference rate, with industry players on the move to identify alternative rates and formulate new processes. Alternative benchmarks will by definition structurally differ from LIBOR. How this will affect existing products that reference LIBOR and new products that may appear remain unknown.

Similarly, uncertain is how the potentially significant impact on both customers and the macro-economy will play out.
While it may not amount to the goal, the transition afoot in 2021 is poised to see financial markets undergo a major change. Even in Japan, although it may feel far away, the future is quickly approaching, and financial institutions should already be pulling out all the stops to tackle the change successfully, considering the scale of the transition required and the impact on financial markets.

To understand the impact of the LIBOR transition and the financial implications for Japan and the Asia-Pacific region better, Celent continues to conduct online surveys and interviews targeting financial institutions and IT vendors. This report features an analysis of LIBOR transition readiness in Japan-based financial markets on the survey “Navigating the LIBOR Transition: Using IT to Adapt to the New Normal.” The survey was conducted in the fall of 2020 with the participation of more than 30 financial services and IT professionals in Japan/APAC.

This post leverages the survey results to shed light on the preparedness, challenges, and measures to address this upcoming change.

Celent: LIBOR Japan Chart

Some survey highlights:

Transition Taxonomy Challenges
Forty-one percent of respondents noted the following as LIBOR transition taxonomy challenges:

  • New benchmarks and pricing function
  • Risk measurement, risk models, risk management approaches
  • Models, valuations, market data, market data management

Thirty percent of respondents noted concerns related to responding to the needs of LIBOR-using clients, specifically in the following areas:

  • Documents (transition, client, and counterparty contracts), transaction details, transaction changes
  • Process change, presenting new benchmarks, document management (across new and old), workflow tools
  • Contract term analysis tools, legal workflow changes

Vendor Solution Assessment
Forty-six percent of respondents noted support for vendor solutions helping with LIBOR-related data issues. Specifically, several respondents gave positive assessment for solutions, including:

  • Risk measurement, risk model, risk management approaches
  • Multiple respondents touched on the need to evaluate solutions, including exposure analysis, portfolio reassessment, and new performance analytic instruments.
  • Respondents offered a certain degree of praise for solutions targeting LIBOR-using customers (27%) and for LIBOR-dependent workflows (23%); however, a mere 5% of respondents voiced support for a LIBOR transition project management office (PMO).

Biggest challenges in the transition
The most popular response was technology, systems, and integration, given by Forty-two percent of financial institutions. Specifically, survey participants gave voice to the following concerns:

  • Impact analysis of proprietary and vendor systems
  • Connectivity
  • Awareness of needed upgrades to the trading system, lending system, and risk management system
  • Establishing technical KPIs required for transition, and establishing an integrated dashboard
  • Establishing a steady-state infrastructure for a mixed-rate environment
  • Coordinating/aligning enterprise architecture/data/analytics

Celent recommends that the LIBOR transition be used as a catalyst to leverage new technologies.

  1. The LIBOR transition process should distinguish between that transition process, which is temporary, and the final, permanent, new normal state.
  2. The costs and resources directed to this should be seen not only as a means to adapt to the new normal, but also as an investment in the market future. This can provide an opportunity to optimize enterprise architecture (EA) through companywide data and workflow reviews across system infrastructure and core business systems.
  3. In each area, it is important to distinguish among the more general-purpose data and processes, specific asset classes, lending products, and customer-dependent technologies, and to set milestones for overall optimization.

Unfortunately, there exists no silver bullet for the change underway across the industry value chain. Besides, it is difficult to put forth a short-term goal for this transition, making it something that should be tackled as a journey with a mid-to-long-term mindset.

Nevertheless, market players have several options to accelerate the transition from LIBOR to alternative benchmarks. Used in isolation, the effectiveness of each of these choices will prove limited; put another way, how these are combined to obtain the intended results will be crucial.

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