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ISLAMABAD: The Economic Coordination Committee (ECC) of the Cabinet has directed Economic Affairs Division (EAD) to prepare an analysis to shift toward Alternative Reference Rate (ARR) in place of London Interbank Offer Rate (LIBOR) to be adopted, like other countries, and submit recommendations to the ECC for consideration, sources close to Finance Minister told Business Recorder.

On December 31, 2021, EAD tabled a summary at the ECC meeting additional agenda and sought permission from Finance Minister, Shaukat Tarin, to present the case in view of urgency. The Chairman, ECC allowed the request to table the summary in consideration of the proviso of Rules 18(6) read with Rule 23(4) rule. LIBOR is a global benchmark/ reference rate on the basis of which transactions involving various financial instruments including loans have been conducted since 1980s.

Due to the post-Global Financial Crisis (2008) volatility and LIBOR scandal in 2012 the need to transition from LIBOR to transparent alternative rates has been reinforced by global regulators. LIBOR was expected to be phased out by the end of calendar year 2021, and financial instruments negotiated on the basis of LIBOR will be renegotiated during 2022-23.

International financial markets and banks have; therefore, initiated the shift to ARRs, which are deemed to be more reliable and resilient. Where numerous term structures were available for LIBOR for different currencies, the ARR for each of the major currencies (USD, EUR, GBP, JPY, RMB, etc.) will be different.

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Bilateral and Multilateral Financial Institutions are still in the process of deciding the final ARR to which they will be transitioning. However, the most expected ARRs in USD will be SOFR from LIBOR USD, BGP to SONIA from LIBOR, JPY to TONA/ TORF from LIBOR JPY and Euro to EURIBOR from LIBOR EUR.

These ARRs are variable like LIBOR and traditionally there has been little difference between LIBOR and ARRs. Nevertheless, there are a few differences: the ARRs are all backward looking while LIBOR is forward looking, the former are secured overnight rates (except for TORF) while the latter is unsecured term rate, and the ARRs are reliable and resilient whereas LIBOR remained liable to manipulation and speculation.

Any economy involved in international transactions especially that which is primarily a borrower has no option but to transition to the ARRs, as LIBOR will no longer be available. It is premature to say anything with regards to the impact of this transition on debt servicing. Multilateral and bilateral creditors too at this point are still engaged in analyzing the impact of this transition on their respective cash flows.

EAD on its part is also undertaking an exercise in conjunction with State Bank of Pakistan and Finance Division to this effect.

The EAD sought approval of the ECC for amendments to give effect to the global transition. Chairman, ECC allowed the request to table the summary in consideration of the proviso of the aforesaid rule. “The transition of LIBOR for major currencies to an Alternative Reference Rate (ARR) is a significant event in global financial markets,” commented Haseeb Haque, Managing Partner of financial services advisory firm, Fieldfisher Capital LLP.

Haque commented that sterling LIBOR ceased to exist as of December 31, 2021 and; therefore, all financial contracts referencing GBP LIBOR should have already moved to an ARR.

The Financial Conduct Authority (FCA) has allowed market participants more time to transition to ARRs by introducing the concept of synthetic LIBOR, a term rate similar to LIBOR, but based on a different calculation methodology. However, the FCA has strongly recommended firms transition contracts to an ARR as soon as possible, as there are no guarantees that synthetic LIBOR will continue to be published beyond 2022.

For USD LIBOR, market participants have until June 2023 to transition legacy financial contracts to the relevant ARR, provided that new financial transactions reference the ARR. Therefore, counterparties will need to be prepared for the transition, he further contended.

Replacing the existing LIBOR benchmark to an ARR requires various considerations such as the proper spread adjustment and ensuring that operational systems are updated. This is because the proposed ARRs are overnight rates rather than term rates, Haque said.

For example, the proposed ARRs for GBP and USD are SONIA and SOFR, respectively, and both are overnight rates. That is to say, there are no three-month or six-month SONIA or SOFR as was the case with the inter-bank offer rates (IBORs). This raises certain complications that need to be addressed,” commented Haque.

Copyright Business Recorder, 2022

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