The end of LIBOR is in sight, and all sectors of the industry are creating procedures to transition to new benchmark rates.
The Secured Overnight Financing Rate (SOFR) is set to become the new yardstick for USD-based financial markets, signalling a shift from the London Interbank Offered Rate (LIBOR). This has led to concerns over potential disruptions to banks and financial services companies. However, for Apak Group, a Sopra Banking Software company, and more importantly our customers, it will be a case of business as usual due to the sheer flexibility and the unlimited number of indexes for interest calculation housed within our platform.
Since its creation in the mid-1980s, LIBOR has been the benchmark interest rate to which investors and banks fix their credit agreements. This was due to it being based on five currencies (the US Dollar, the British Pound, the Euro, the Japanese Yen and the Swiss Franc), and the fact that it serves seven different maturities (overnight, one week, and one, two, three, six and 12 months).
The combination of these five currencies and seven different maturities leads to a total of 35 different LIBOR rates being determined and reported for each business day. However, LIBOR was not without its flaws.
LIBOR is based solely on estimates from the global banks that are surveyed. The downside of this became apparent in 2012, when certain banks were found to have falsely inflated or deflated their rates in order to fraudulently profit from trades or create a misleading perception as to their creditworthiness.
Therefore, over the past year, US regulators have taken great strides forward in implementing LIBOR’s replacement and, after months of work, the Federal Reserve Bank of New York began publishing SOFR in April 2018.
Currently, both LIBOR and SOFR coexist, with the latter taking over as the dominant benchmark for USD-based derivatives and credit products, and LIBOR being phased out by the end of 2021. The adjustment to a new benchmark rate involves considerable difficulty due to the volume of LIBOR-based contracts outstanding in 2018.
The main impact for Apak Group clients using WFS will be with the legacy loans that utilize LIBOR. As such, we are already working with our North American clients to evaluate those that use LIBOR and the type and number of loans associated with the legacy rate.
In the case of Wholesale, the loan terms are shorter; therefore, in some cases we are working with the client to change from LIBOR before the end of 2021 for future floorplan loans. For longer term loans, we will need to look at the options for updating the rates from LIBOR to the client-defined replacements. For new projects, the replacement of LIBOR will be discussed in the definition phase and form part of the project itself.
A key attribute of WFS is that it allows an unlimited number of indexes for interest calculation and how it is determined. Once agreed, these rates would then be applied, defined and maintained by the client. These rates can be assigned at the finance plan level and then would be based on differing interest calculations, calculated either as simple or compounded options.
SOFR makes no recommendation as to whether a simple or compound calculation should be applied and, as such, it is up to the individual client to select a preferred rate.
This shift is the biggest change to hit lending in 40 years, and there will be operational ramifications and financial challenges. Furthermore, the sheer volume of lending portfolios that will need to be adjusted is staggering.
Our clients can rest easy, though. WFS is a single global enterprise application that is implemented worldwide, interest calculations and rate index utilization are key components of that. There is, therefore, already significant flexibility within the system for configuration to support the upcoming changes.