RBA’s Debelle warns against buy-side Libor complacency

Central banker also says Australian dollar swaps may migrate to the cash rate if other Ibors end

Guy Debelle: transition to alternative reference rates must happen

Image: TRACEY NEARMY/AAP/PA Images

Buy-side firms must stop being complacent and urgently prepare for Libor’s possible disappearance after 2021, a senior Australian central banker has warned.

Appearing by video link at an International Swaps and Derivatives Association event in Hong Kong on May 15, Guy Debelle, deputy governor of the Reserve Bank of Australia (RBA), said awareness of the need to transition to alternative reference rates must improve across the market. 

“On the regulatory side, there is a very clear recognition of what needs to be accomplished, and I think there is very much recognition on the bank side that something needs to change,” he said.

“But there is not so much recognition on the buy side of the market, or with the other users of Libor. I think they may be hoping someone will come along and fix the problem for them – I just don’t think anyone should be confident that is going to happen.”

An investor at a life insurance company agreed there is a gap in awareness between the sell and buy sides on the Libor transition, but insisted outreach to the buy side by central banks and regulators must improve. 

The UK Financial Conduct Authority announced last year that it will give up its power to compel banks on the Libor panel to make submissions to the rate after 2021 – casting doubt over the benchmark’s future. Banks have been increasingly reluctant to participate in the benchmark, as the decline in interbank unsecured funding has meant many submissions are now based on expert judgment. 

Alternative risk-free rates have been developed in a number of currencies, and industry groups convened by Isda have been working on fallbacks should Libor disappear after the 2021 deadline set by the FCA. UK and US regulators expect the market to shift legacy swap contracts from referencing Libor to reference risk-free rates such as reformed Sonia and the new US secured overnight financing rate, in a bid to minimise disruption ahead of any Libor cessation.

Asked by Scott O’Malia, Isda’s chief executive, how confident he was that “what needs to be done is getting done”, Debelle said: “not that high”.

On the regulatory side, there is a very clear recognition of what needs to be accomplished, but there is not so much recognition on the buy

Guy Debelle, Reserve Bank of Australia

Regulators in Australia have adopted a multi-rate approach. Market participants are being encouraged to adopt an RFR, the overnight cash rate, for floating-rate notes issued by governments, corporates and securitisation trusts. But the central bank believes other products – derivatives and corporate loans – can continue to be fixed using the existing credit-based benchmark, the Bank Bill Swap Rate (BBSW). 

However, the Australian market still has a large exposure to Libor, with the RBA estimating roughly $5 trillion in contracts tied to the benchmark. Debelle said firms need to begin reducing their exposure to the benchmark on their books immediately. 

“A large share of these contracts have short durations, often three months or less, so these will roll off well ahead of 2021, but they should not continue to be replaced with another short-dated contract referencing Libor,” Debelle said. 

Should Libor disappear in other currencies after 2021 Debelle believes the market might gradually migrate away from the BBSW to the cash rate. For example, some market participants have previously expressed concern the basis could be affected if two reference rates on a cross-currency swap have different underlyings. 

“In the event Libor was to be discontinued, with contracts transitioning to RFRs, there may be some corresponding migration away from BBSW towards the cash rate,” he said. “This will depend on how international markets for products such as derivatives and syndicated loans end up adapting in a post-Libor world.”

Awareness gap

Benjamin Deng, head of group investment solutions and derivatives at the AIA Group in Hong Kong, said some uncertainty remains on the buy side in Asia around the future of Libor, and what needs to be done to transition away from the reference rate.

He called for central banks and regulators to be more proactive in explaining what needs to be done over the next three years to reduce the Libor risk on their books. 

“I think 2021 is a sufficient timeline for European and US companies, but Asian companies are still trying to understand what this means,” he said.

“Our Hong Kong, Malaysian, and Singaporean regulators – they need to be doing more to educate and reach out to the industry. Maybe there are also European case studies we could borrow that would tell us how this is going to impact their P&L.”

Debelle added that Libor may well continue to exist after banks are no longer compelled to contribute to the panel. It would be ill-advised for anyone in the market to count on that though, he added. 

“I’m not saying Libor is going away in 2021” the deputy governor added. “But I’m certainly not assuming it won’t be.”