IBOR reform

Tony Clifford, Partner, Ernst & Young LLP and Fiona Thomson, Managing Director, International Head of Accounting Policy, Goldman Sachs International

Tony provided an update on some of the matters which the EY organization intended to include in its comment letter on the exposure draft (ED) on IBOR reform. He also mentioned some of the key accounting challenges post-reform (phase two). Fiona discussed practical observations from Goldman Sachs’ experience with IBOR transition to date.

At the time of the conference the estimated outstanding notional amount of IBOR exposures across global markets and currencies was US$370 trillion. Most of these exposures were referenced to either London interbank offered rates (LIBOR) or Euribor. While the most common tenor is three months, tenors generally range from overnight rates to 12-month rates. Given the size of the global exposure and the extent to which interest rate markets rely on IBORs, understanding the impact of the transition to risk-free rates (RFRs) is an important and topical matter for banks around the world.

Tony Clifford

Tony’s presentation followed on from Sue Lloyd’s discussion. He started by explaining why the topic has become so important in the current reporting cycle compared to previous cycles. The accounting and valuation challenges surrounding IBOR reform become more significant as the point of transition approaches. This is, in part, because at some point IBORs will cease to be the main driver of floating interest rate markets and also because IBORs and other RFRs have historically been correlated in the long-term, but have differed in the short-term, particularly under stressed market conditions. Therefore, as the transition point approaches, the possibility that IBORs and RFRs could differ significantly increases.

Therefore, Tony stressed that the points dealt with in the IBOR reform ED are urgent and that the guidance and relief contained in the ED are much needed. In addition to the points covered by the ED, Tony highlighted some additional areas that could be considered under phase one, such as:

  • Whether the scope of the relief should extend to hedges of cross currency interest rate risk and inflation rates
  • What the ED envisages when it requires ‘retrospective’ application
  • Whether relief can be provided for hedges which fail the retrospective effectiveness test (the 80-125% test) due to IBOR reform

While most participants expressed sympathy with the need for relief during a floor discussion on the final point, there was general acknowledgement that it is likely to be difficult to differentiate between those hedges which fail the 80-125% solely due to IBOR reform and those which would have failed anyway regardless of IBOR reform. Sue Lloyd urged participants who intended to ask for relief from the retrospective effectiveness test in their comment letters to also propose effective suggestions as to how the IBOR reform impact could be isolated.

Tony went on to mention some of the key phase two challenges which were much the same as those discussed by Sue in her presentation. He recognized the staff’s challenges regarding time and echoed her call for participants to focus on the key issues in their comment letters and industry discussions.

For further information on IBOR reform, refer to the following EY publications:

Fiona Thomson

Fiona highlighted the importance of this project to Goldman Sachs. While noting that there is no one-size-fits-all approach to a project of this nature, the key characteristic of Goldman Sachs’ project has been senior management taking ownership of and accountability for the project. This support has allowed her team to make efficient and effective progress.

The Goldman Sachs project has been led by the treasury function, but has required multi-disciplinary, global input. The multi-disciplinary input is important because the reform affects not only accounting, but also the operational, tax, regulatory, legal and IT functions. The global input has been important due to the diversity in the nature and timing of reforms in different jurisdictions, not to mention the differences in contracts.

A key step in the implementation has been the identification of the group’s IBOR exposures and to divide the exposures into buckets based on common features. This has allowed for targeted reviews of fall-back clauses, and high-level quantification of the possible impact per bucket. This data has then been used to prioritise remediation efforts on existing balances.

Fiona also explained that Goldman Sachs has recently concluded its first RFR debt issuances which have been positively received by the market. However, a key challenge which may be relevant for both issuers and for potential investors is the lack of liquidity in longer-term hedging instruments to either hedge floating rate issuances back to fixed, or to hedge fixed rate risk to RFR. This has potentially contributed to the term of the RFR issuances in the market to date being relatively short. Fiona’s expectation is that this will change over time as the entities begin to provide RFR products which cater for the broader requirements of the interest rate market.

For further information on IBOR reform, refer to the following EY publications:

IFRS developments – IBOR reform: issues 144, 145 and 148