Introduction
RBI on discontinuation of Libor
Comment
The cessation of the London Interbank Offered Rate (Libor) after 31 December 2021 is no longer new information. However, several market participants in India continue to drag their feet during the transition process. In the Progress Report to the G20 on Libor Transition Issues, the Financial Stability Board (the agency responsible for monitoring and making recommendations on the global financial system) highlighted its concern that new lending by financial institutions referencing the Libor has increased the stock of contracts affected by the Libor transition.
Against this backdrop, the Reserve Bank of India (RBI), the central banking regulator in India, has issued much needed directions to banks and financial institutions in its 8 July 2021 circular (Libor transition circular), which aims to accelerate the Libor transition process. The Libor transition circular encourages banks and financial institutions to cease, and encourage their customers to cease, entering into new financial contracts that reference Libor as a benchmark and instead use any widely accepted alternative reference rate (ARR) as soon as practicable and, in any case, by 31 December 2021. Previously, in August 2020, the RBI requested banks to frame a board-approved plan outlining an assessment of exposures linked to the Libor and the steps to be taken to address risks arising from the cessation of Libor, including preparation for the adoption of an ARR.
On 5 March 2021 the Intercontinental Exchange Benchmark Administration (IBA) notified the UK Financial Conduct Authority (UK FCA) that following the results of its consultation, it will no longer:
- have the necessary inputs from panel banks to publish representative sterling, Euro, Swiss franc and Japanese yen settings and one-week and two-month US dollar (USD) Libor settings after 31 December 2021; and
- be able to publish representative settings of the other USD Libor tenors after 30 June 2023.
Following this, the UK FCA announced the future cessation or loss of representativeness of the 35 Libor benchmark settings currently published by the IBA (FCA announcement).
The impending transition for banks and financial institutions in India as well can therefore no longer be ignored.
RBI on discontinuation of Libor
Some of the RBI's key requirements in this regard are as follows.
Review of Libor exposures
The RBI now requires banks and financial institutions to undertake a comprehensive review of all direct and indirect Libor exposures and put in place a framework to mitigate risks arising from such exposures on account of transitional issues, including valuation and contractual clauses.
Continuation of Libor only in certain cases
Similar to the stance taken by the UK FCA, the RBI has taken note that the continuation of certain USD Libor settings to be published until 30 June 2023 is primarily aimed at ensuring roll-off of USD Libor-linked legacy contracts and is not to encourage continued reliance on Libor. The RBI has therefore advised that contracts referencing Libor undertaken after 31 December 2021 should be only for managing risks arising out of Libor contracts (eg, hedging contracts including transactions for hedging the consequent Libor exposure contracted on or before 31 December 2021).
Fallback and rate-switch clauses
The RBI requires banks and financial institutions to incorporate robust fallback clauses, preferably well before the respective cessation dates, in all financial contracts that reference Libor (where the maturity date of the contract is after the announced cessation date of the respective Libor settings). The RBI has also recommended reference to the standard fallback clauses developed by agencies such as:
- the International Swaps and Derivatives Association;
- the IBA;
- the Loan Market Association;
- the Asia Pacific Loan Market Association; and
- the Bankers Association for Finance and Trade.
These agencies have issued guidelines, fallback protocols and rate-switching clauses to accommodate the Libor transition. These may be used by banks and financial institutions for risk mitigation.
Transition away from Mifor
As the Mumbai Interbank Forward Outright Rate (Mifor) published by the Financial Benchmarks India Private Limited (FBIL) references the Libor, the RBI has also directed banks and financial institutions to cease using the Mifor as soon as practicable and, in any event, by 31 December 2021. Contracts referencing Mifor are to be undertaken after 31 December 2021 only for managing risks arising out of Mifor contracts. The RBI has recommended the use of the daily adjusted Mifor published by the FBIL for legacy contracts and modified Mifor rates published by the FBIL for fresh contracts.
Fresh products referencing ARR and client sensitisation
Banks and financial institutions have been directed to put in place the necessary infrastructure to be able to offer fresh products referencing the ARR. The RBI has recognised and highlighted that efforts to sensitise clients about the transition (as well as the methodology and convention changes involved in the alternatives to Libor) will be critical in this context.
With less than six months remaining until the cessation of Libor, the RBI's Libor transition circular could be the driving force that is needed to ensure that at least regulated entitles take the necessary actions in the evolution from Libor to a more well-rounded and representative alternative rate within definitive timelines. Like various other jurisdictions, India may also require further directions from its financial services regulator on the alternative rate. Legislative solutions to mitigate risk in relation to legacy contracts and address the cessation of Libor may also be required, including regarding the replacement of the Libor provisions under the Master Directions on External Commercial Borrowings in India. While various financial agencies and banking regulators globally have been issuing guidelines to minimise possible market disruption due to the Libor transition, definitive and timely action by market participants is the main priority and the onus remains on such market participants to minimise the risks associated with the transition.
For further information on this topic please contact Hufriz Wadia or Neeraj Nainani at AZB & Partners by telephone (+91 22 4072 9999) or email ([email protected] or [email protected]). The AZB & Partners website can be accessed at www.azbpartners.com.