Is Your Supply Chain Finance Program Prepared for the LIBOR Transition?

Updated March 22, 2021: On March 5, 2021, the ICE Benchmark Administration (IBA) officially confirmed plans to postpone the phase out of USD LIBOR for overnight and 1, 3, 6, and 12 months until June 30, 2023. The phase out for USD LIBOR for 1 week and 2 months is still scheduled to be complete by December 31, 2021.

After reflection on the continued disruptions affecting the global economy, the ICE Benchmark Administration announced in late November a plan to push back the phasing out of LIBOR for the U.S. dollar. Originally scheduled for December 2021, the deadline will now be extended to June 30, 2023 as currently proposed.

According to the Fed, the extension will allow a majority of contracts tied to LIBOR to “expire naturally and avoid having to shift them to a new benchmark.” This is welcome news. Our experience working with banks as they prepare for this transition has given us insight into the scope of adjustments that will need to be made on their part. There is a desire to minimize disruption given current market conditions and the Fed’s guidance aligns with that. The consultation period for this extension ends at the end of this month, so we anticipate a final decision soon.

Since the 1980s, LIBOR (London Inter-bank Offered Rate) has effectively served as the benchmark rate for loans across the world. During the global financial crisis, however, it drew scrutiny when financial institutions manipulated it to boost returns and hide financial weaknesses.

Ever since, there have been global calls for a replacement. Leading the charge has been the Fed in the U.S., the Bank of England and Financial Conduct Authority in the UK. For more information on why it’s going away, read my previous blog.

With the transition on the horizon (albeit further out), many companies that use supply chain finance to improve cash flow are wondering what it might mean for their program funding and how they can prepare. If you are a PrimeRevenue customer, or a supplier participating in a PrimeRevenue-led supply chain finance program, you can rest assured. Our funders are taking the transition seriously and proactively preparing for a transition that will likely have negligible, if any, impact on program funding.

Comparing LIBOR to the Alternatives

The main difference between alternative rates and LIBOR is that LIBOR is based on forecasts provided by banks while its replacements are based on accounting rates of return (ARR) from actual transactions.

There are a multitude of alternative rates throughout the world, but the ones that have gained the most traction are: SOFR for USD, SONIA for GBP, TONAR for JPY, ESTER for EUR, and SARON for CHF. Here is a brief overview of each:

• Secured Overnight Financing Rate (SOFR): SOFR is published by the New York Federal Reserve and will be the replacement for the U.S. market. It’s a secured rate reflecting transactions backed by U.S. Treasuries, compared to LIBOR which is unsecured. There are two types of SOFR: simple interest and compound interest. Simple interest is very similar to LIBOR, so it will be a relatively light lift to switch to this rate. Compound interest requires more back-office work for the banks, which is why it currently seems like most banks will most likely opt for simple interest SOFR for trade finance.
• Sterling Overnight Index Average (SONIA): SONIA is the effective overnight interest rate paid by banks for unsecured transactions in the British sterling market. SONIA has been under the oversight of the Bank of England since 2016 and was most recently reformed in 2018. The key difference between SONIA (and other rate alternatives) and LIBOR is that LIBOR is forward-looking – it is agreed upon at the start of an interest period and reflects the market’s expectations of the new rates in the future. SONIA is backward-looking and cannot be determined until the end of an agreed interest period, although there are current trials for a forward-looking SONIA structure.
• Tokyo Overnight Average Rate (TONAR): TONAR is an unsecured interbank overnight interest rate and has been recommended by the Bank of Japan as its preferred risk-free reference rate since 2016. It’s based on transactions in the uncollateralized overnight borrowing market.
• Euro Short Term Rate (ESTER): ESTER is based on the borrowing cost of the wholesale euro unsecured overnight borrowing costs of euro-area banks. It reflects an average of approximately 500 daily transactions amounting for nearly €40 billion with a broad range of participants including pension funds and insurance companies. This is different from LIBOR in that it’s based on more representative input and much higher transaction volume than the interbank market.
• Swiss Average Rate Overnight (SARON): Like SOFR, SARON is based on overnight trades between financial institutions, but in the Swiss franc–denominated repurchase agreement market. SARON is based specifically on transactions between financial institutions. Like SONIA, SARON was already in use before scandal overtook LIBOR. Banks are already selling SARON-based mortgages, although other credit products are still largely priced off of LIBOR.

What Does This Change of Plans Mean for Supply Chain Finance Stakeholders?

Fortunately, all stakeholders involved in PrimeRevenue-led supply chain finance (and finance, in general) will benefit from a potential extended deadline for phasing out LIBOR.

• Banks: Financial institutions will have a longer runway to work through operational changes and concerns. This includes working with their technology partners like PrimeRevenue to strengthen their game plan for the transition.
• Suppliers: A large portion of PrimeRevenue’s transactions are in USD, which means it will be largely business as usual until mid-2023. When the deadline comes to transition, there will be minimal changes to current pricing/rate methodology for suppliers moving to simple-interest SOFR programs. Plus, suppliers will have more time to understand replacement rate calculation structures.
• Buyers: Like suppliers, buyers will have more time to educate their treasury/finance and procurement teams on LIBOR’s replacements so they can better respond to supplier questions.

PrimeRevenue will continue to publish reports with both education and guidance. We are actively engaged with financial institutions’ planning efforts and are providing counsel to our buyer customers as they seek to better understand these changes. We’ll continue to pass along the knowledge gained from these interactions as new updates emerge.

How You Can Proactively Prepare for the Transition Away From LIBOR

So far, the prevailing trend is that LIBOR will be replaced with similar simple interest, forward-looking rate calculation structures. This approach is similar to LIBOR’s and is already supported by the PrimeRevenue platform.

Meanwhile, we are taking steps to ensure our platform is ready to support our funder partners’ preferred interest rate calculation method. Fortunately, this isn’t new territory for us. Our customers already benefit from our platform’s ability to support multiple rate structures. As a multi-funder supply chain finance provider, we are experienced working with funders who use their own proprietary, non-LIBOR interest rate calculation structures.

When asked by customers how they can best prepare for this change, my response is simple – you’re already covered! As I mentioned earlier, PrimeRevenue is proactively working with our banking partners around the world to make sure the transition away from LIBOR is as smooth as possible for our clients. We’re providing regular guidance on choosing a rate structure that favors all parties – banks, suppliers and buyers. Our solutions and team are ready and capable. If any changes are required, know we are one step ahead and ready to pivot for whatever may happen.