IBORs, Risk Free Rates and Beer LIBOR?

Imagine you walk into a bar (and I mean imagine, as it is difficult to do so at the moment!) and ask for a beer. The barman says “. A Beer? Well, we have this sparkling mineral water. Very nice!

You: But I want a beer!

Barman: Yes, but the mineral water is risk free!

You: How do I get a beer?

Barman: Well, buy this mineral water, and take it to the counter down there.

You: What will that do?

Barman: He’ll sell you a beer overlay

You: So he will make it a beer?

Barman: No, but something close

You: What will it cost me?

Barman: Oh, 1,2,3 dollars or so

You: Can’t you be certain?

Barman: Oh no, you’ll just have to trust me

You: Trust you, after Beer Libor….!

Now this may be imagined, but it reflects some very real questions. Recently, a Senior Central Banker suggested 90% of borrowers should accept Risk Free Rates (RFRs) as the borrowing rate once LIBOR is no more. Other industry figures suggest larger borrowers might, but smaller borrowers might not. Certainly most corporates accessing RFR finding have been large. One f the obvious questions borrowers would be asking is: what's involved with borrowing at RFRs?

This is a slightly different question to the one the FTA Technical Committee covered last year about how to prepare for IBOR Fallbacks. The prospect of borrowing at RFRs raises some pretty big questions and answers are proving hard to come by:

1. Can your lenders lend at that rate? No, that's not a joke. Banks have large programs underway to convert many aspects of their operations from using IBORs to using RFRs. This aspect is no different. Their systems have to be capable of managing RFR linked loans, and this will probably require a lot of work.

2. Can you borrow on that basis? Do you have the systems capable of changing from a rate known in advance to one calculated in arrears?

3. If there are no term RFRs, are you happy to enter into short term derivatives to achieve a synthetic term RFR?

4. How easy will these borrowings be explained to stakeholders? Will they accept in arrears rates or require in advance (See 3 above).

5. Impacts on hedge accounting are unclear. IF you create synthetic term RFRs, will they qualify and if you then hedged long term, would you need to unwind?

6. How would you document these loans? Work is still being done on fallback language, although there are debt capital markets issues (with varied terms and methods to calculate interest rates).

7. In Australia, should you be concerned, after all, BBSW is still around?

I expect more than a few of these questions will be answered before long, and despite the disruption we're facing due to COVID-19 this transition will continue.

Perhaps now is the time to step back, have a quiet beer (or beverage of your choice), be thankful there's no issue in the beverage market, and think through the possible answers to the questions here.