Over the last few years it became clear that LIBOR – the world’s most popular rates benchmark upon which hundreds of trillions of dollars’ worth of investor assets and derivatives are valued – will eventually be phased out, kicking off one of the biggest transformations in financial services history.
LIBOR, which stands for the “London Inter-bank Offered Rate,” may cease to be supported by banks and regulators by the end of 2021, and such an integral, industry-wide reference rate must therefore be replaced. In preparation, Mizuho, along with financial services firms everywhere, needs to support the migration of those hundreds of trillions of dollars of assets to comparable benchmarks.
Although the vast majority of instruments will eventually be moved to new risk-free rates – for USD it is the Federal Reserve Bank of New York’s Secured Overnight Financing Rate (SOFR) – the move is not just a simple search and replace. Hear from our team of LIBOR experts to find out how Mizuho is approaching the transition.
Interview transcript:
Jerry Rizzieri, President & CEO, Mizuho Securities USA: The IBOR Project is not just a Mizuho Americas initiative. This is a global financial group initiative and it's also, something that stretches across the entire industry. We have hundreds of employees across the region working on this project from finance, legal, compliance, operations, IT. It's incredibly important that the organization mobilize around this effort so that, not only is Mizuho ready, but that our clients are positioned for the transition.
Christoph Rode, Executive Director, Fixed Income: IBOR obviously stands for Interbank Offered Rate. LIBOR is the London Interbank Offered Rate. IBORs have been in existence since the late 60s, early 70s, and have been referenced in a number of contracts since then. Not only in derivatives and bond securities or any of these things, but also in vendor contracts, in consumer loans, in mortgages, in car loans, everywhere. This new rate, this SOFR rate, is based on the repo markets. The repo market is very large and the assumption is that it's very hard to manipulate by anyone in the private sector. So by comparison, the LIBOR, underlying LIBOR transactions, they account for, maybe like 500 million dollars in size, per day. Typical daily volume in the repo markets for US dollars is 800 to a trillion dollars. So, it's a factor of a 1,000, 2,000 bigger. So that makes it already more robust. And that's really the main goal of this whole exercise, to have a robust rate that people can reference.
Scott Berman, Director, Americas Treasury Department: The difference between SOFR and LIBOR is that the SOFR rate over an interest period will not be known in advance. LIBOR, for an interest period such as three months, is known today, and that rate is the same rate over the three month period. But SOFR, because it's an overnight rate, will vary every day, and not until the end of the interest rate period, if that's a three month period, where we actually know, what the compounded average of SOFR is. So it operates differently, and while the rate can be observed on a given day, it will most likely be used as an average over some period of time.
Sherif Lotfi, Managing Director, Strategic Solutions Group: When we think of the LIBOR transition, it's much more complex than people think. So people think of it as a simple search and replace, but it touches so many different parts of it, that if you think of it as narrowly as that, it's a bit like the old tale of the blind men and the elephant. Sort of, one pulling the trunk and the side of the elephant thinking that it's a wall et cetera, right? And the same thing here, we have to think of it as a much more holistic thing because it touches so many different parts of the financial system and of this institution.
Christina Buoninfante, Director, Enterprise Performance & Change: When I think about the scope of the program, it's pretty immense. I have to say there's over 2,000 lending agreements that are exposed to LIBOR. We have over 80,000 derivatives contracts that have exposure to LIBOR. There's over 40 systems that are impacted, over 40 models that need to be re-documented and validated. It's a lot.
Christoph Rode: I think LIBOR's on the scale of Y2K times 10. Just because it's so widespread in all the different aspects of financial markets.
Sherif Lotfi: Actually, success is a bit like Y2K that nobody knows. Y2K, like, the transition happened and nothing happened, and so everybody says, oh, it wasn't a big deal. Well, it was actually a success because of all the work that went into it that made it not a big deal. In some ways, if that happens for us, it means we're going for the industry as a whole, we transition to this new risk free rates and reference rates, there's no hiccups. There's no hiccups in markets, there's no hiccups in evaluations, there's no client that feels like they've been left behind, that client communication has happened, sort of, smoothly, all the IT systems work, the different jurisdictions in the world do manage the transition in relative harmony, then we've had a very, very successful program.
Christoph Rode: Everyone in the financial markets need to know that this transition is happening. LIBOR is going to go away eventually. New products have to be created and we need to make sure that we deal with existing legacy contracts, that we know what's actually happens when LIBOR disappears. It's really important, because right now there's so many contracts that don't even specify what happens if LIBOR is not quoted. So there needs to be fallback protection in all these contracts, everyone needs to beware of this, because there may be some niches that people haven't thought about, right? So there's always an opportunity for people to think about their own in- little space and niches they work in, and to see if there's any exposure.
Christina Buoninfante: We need to be ready, as Mizuho, to offer these new alternative rates to our clients. So almost every single employee plays a part there. Whether you're in the HR function or the finance function or the risk function, you may not be talking to clients on a daily basis but somewhere in the bank, you're supporting, our, our offerings.
Sherif Lotfi: When you have a system has so many pieces to it, the one thing which we can never lose sight of, is how we interact about this transaction with our clients. So what's our client communication strategy? What's going to happen with our clients? Are our clients ready? And make sure that there is adequate representation in our own processes, about what the front office needs in terms, to have a successful client transition.