The global banking industry has been using interbank offered rates (IBORs), especially the London Interbank Offered Rate (LIBOR), for some fifty years now. But as with most regulatory-driven changes, the initiators behind the transition feel that the approach is legacy and no longer meets the demands of the current market.
Van der Windt, who has been around in the financial services industry for over two decades, has first hand seen many of the drawbacks of the IBOR system. “This rate forms the interest rate basis for just about any debt instruments in the industry,” he said, “from financial transactions as mortgage-backed securities, to corporate loans, government bonds and credit cards payments.”
Demonstrating its importance to market mechanics, IBOR and LIBOR are estimated to underpin a massive $300 trillion worth of loans worldwide. With such high stakes on the table, it was a matter of time for foul play to enter the stage. “Over the past decade, the internal bank lending market was winding down, and against this backdrop, certain banks [a group of major global banks] were colluding and manipulate rates for the purpose of profit,” explained Van der Windt.
Evidence uncovered a few years ago found that this collusion had been going on since at least 2005, possibly earlier than 2003, with trillions in value affected. Regulators in both the United States and Europe have since levied some $9 billion in fines on banks involved in the scandal, as well as a slew of criminal charges. But more importantly, said Van der Windt, the scandal has prompted change for the better.
A new system comprised of several benchmarks – which vary by region/jurisdiction – will replace IBOR and LIBOR in the coming 15 months. The US for instance has introduced the Secured Overnight Financing Rate (SOFR), while Europe is seeing the the Euro Short-Term Rate (ESTR) take centre stage.
“A massive impact”
The Varrlyn partner says that there still is much debate and alignment on which methods will prevail as the new market standard, but whatever the outcome, it means a massive impact for banks. “This is by far the largest regulatory transition banks have been facing since the turn of the century.”
It doesn’t need much imagination to understand why. “Every financial product within banks, from retail and wholesale to corporate and investment products, is impacted. On top of this, as the interbank rates are at the heart of the value chain from sales through to technology, the impact cuts through the entire organisation.”
To put the scale into perspective: “At Varrlyn, we have worked on many of the most impactful regulatory changes in the sector; EMIR, Dodd Frank, to name a few. But while these triggered major change, they always were focused on one or two dimensions – being products, divisions or regulatory scope. But this….,” says Van der Windt after a deep breath, “is something of a completely different magnitude.”
The challenge for banks is not just to oversee this change, but also to be timely. “Because if they don’t hit the right preparations on time, meaning that they are fully onboarded on new rates when the IBORs phase out, it instantly makes their products obsolete. The price tag of such mismanagement could be unprecedented, Van der Windt warns.
“We’ve worked on many regulatory changes in the sector… but this is something of a completely different magnitude.”
– Stephan van der Windt, Varrlyn
The current rates will cease at the end of 2021, when LIBOR will either disappear entirely or become unreliable, but some rates may be adopted before the end of next year. Add to this other pressure cookers that banks will be facing, including uncertainty on planning, conversion tables and “much, much more,” and the picture is complete.
Progress is being made, “every rate has its own working group which helps establish clarity and lays down timelines, but despite all their efforts, it will by no means be able to remove all uncertainties,” he said.
This is where Varrlyn comes in. The consultancy, founded in 2010 by former Accenture seniors, is a specialist in business technology transformations in the Benelux banking industry, and has notched top players including ABN Amro and Rabobank as its clients. The firm supports with programme and project management, coordinating change as part of a wider transformation agenda, designing processes and solutions, linking the business with IT, technology implementation and solution building.
Varrlyn’s sweet spot lies in the regulatory space and its impact on the front to back-office to risk and finance value chain. Its track record in this space has positioned it as a serious boutique alternative to the well-known giants such as the Big Four, Accenture and Capgemini for IBOR and LIBOR work. For one banking major in the Netherlands, the consultancy helped leaders with conducting an impact assessment of the transition.
“We helped them define what the change is, the impact on existing processes, system and not to forget people, and with the gap analysis and resulting actions plans.” With knowledge sharing one of Varrlyn’s key pillars, the consultancy handed over its work to the client, for its internal teams to take it from there. “We’ve also delivered impact assessment for a number of smaller financial institutions,” confirmed Van der Windt.
Amid the coronavirus, banks are now expected to up their game as they embark on a historic transformation. For many, a daunting prospect, but for Varrlyn, “this is what makes our hearts tick faster,” said Van der Windt, adding “This opportunity is so unique, big, complex, and it even can help the industry drive positive change, that makes us enthusiastic.”