Impact of Libor Review on Trade Finance in India

Note: Since this article was written, below regulation has been implemented. Refer Article: Change in LIBOR Tenures and Impact on Trade Finance

Article “Pushing the reset button on Libor” covers broader issue in relation to Libor and its recommendations are classified in below categories,

  1. Regulation – Introducing a new regulatory structure for LIBOR, including criminal sanctions for those who attempt to manipulate it.
  2. Governance – Transferring the oversight and governance role from the British Bankers’ Association.
  3. The rate itself – A range of technical changes to make the system work better, including streamlining a lot of the currencies and maturities currently used.

From Trade Credit (Buyers Credit, Suppliers Credit etc.) perspective, recommendation under above point 3 is the most relevant. It is further classified as,

1. Review has recommended that the number of currencies and tenors for which LIBOR is published to be reduced. Specifically:

  • Publication of all LIBORs for Australian Dollars, Canadian Dollars, Danish Kroner, New Zealand Dollars and Swedish Kronor should be discontinued;
  • For remaining currencies, publication of LIBOR for 4 months, 5 months, 7 months, 8 months, 10 months and 11 months tenors should be discontinued;
  • Continued publication of overnight, 1 week, 2 weeks, 2 months and 9 months should also be re-considered.

Should this recommendation be implemented in full, the number of LIBOR benchmarks published daily could be reduced from 150 to 20. Thus, either taking buyers credit in the above currencies will cease to exist or buyers credit providing bank will have to find an alternate benchmark for lending against these currencies. For example,  instead of Swedish Krona Libor, buyers credit bank might start using the Stockholm Inter-bank Offer Rate (STIBOR).

Same way, in the absence of certain tenors, interpolation or extrapolation techniques could be used to create intermediate maturities between existing data points.            For example, if some is looking for buyers credit for tenure of 120 days and in future when 4 Month Libor is not available, buyers credit providing banks might either use 3 month Libor or 6 month Libor and adjust margin charged over Libor  accordingly. Or use an alternate benchmark which offer a reference rate for that tenure. But that is highly unlikely to happen as it would create difficulties to manage funds under different maturities and benchmark for buyers credit providing banks.

2. Review has recommended that market participants using LIBOR should be encouraged to consider and evaluate their use of LIBOR, including whether standard contracts contain adequate contingency provisions covering the event of LIBOR not being produced.       This might result in buyers credit providing bank making changes in the Letter of Undertaking (LOU) / Letter of Comfort (LOC) format to  introduce the above contingency provision. However it needs to be seen how would local bank react to these changes.

3. Review has recommended that market participants should be encouraged to consider and examine their present use of LIBOR as a reference rate. Is it the most appropriate reference rate for transactions that they undertake? Or are there other benchmark rates that are more appropriate? In future we might even see a complete new benchmark being used for Trade Credit transactions. Like it happened with Euro transaction. Most of the Euro transactions now day are happening in EURIBOR instead of Euro Libor.

The Review has recommended a 12-month transition period for the full implementation of these changes. However, some LIBORs may be able to be reduced in a shorter time period, perhaps within six months. This timeframe would give market participants time to adapt to alternative benchmarks. It would also give market participants the time to establish market-wide solutions, where appropriate.

To keep the transaction smooth, RBI, Industry Association, Industry and Banks will have to come together and work out a clear road map on future of Trade Credit and all other product which are linked to LIBOR .

Reference

  1. The Wheathley Review of Libor : Final Report : Dated 28-09-2012
  2. HM Treasury : The Wheatley Review
  3. Speech by Martin Wheatley – Managing Director, FSA, and CEO Designate, FCA at the Wheatley Review of LIBOR : Dated 28-09-2012
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