By Ajay Agrawal, CEO and Co-founder, SirionLabs
After spending nearly half a century as the lynchpin of the global financial industry, LIBOR (London Interbank Offered Rate) is set to retire in 2021. The impending transition from LIBOR to ARR (Alternative Reference Rates) is widely recognized as the largest change management program in the history of the financial services industry. And with good reason: it is expected to impact contracts with a total value exceeding USD 300 trillion.
You could argue that we have witnessed such events before – especially in the aftermath of the Great Recession – when regulations such as the Frank-Dodd Act and EBA directives were announced. But the LIBOR phaseout is unlike anything we have seen before because it will have an impact on every market participant. Clients, investors, buy-side and sell-side entities alike will have to remediate contracts/agreements and overhaul their processes and systems.
The clock is ticking. At this point, we have a little less than a year till the December 2021 deadline, which regulators have refused to push back despite the ongoing COVID-19 crisis.
However, moving on will not be easy.
Where’s the starting point for financial institutions?
Broadly speaking, enterprises will have to begin by reviewing all existing contracts in their portfolio with the goal of identifying the ones that have exposure to LIBOR. This is ultimately going to be a mammoth task in itself because a typical financial services business has thousands of agreements in place at any given time. There won’t be enough time to drive the review process manually without compromising quality. Contracts that refer to LIBOR can’t just be amended with a new ARR. Some contracts use fallback rate and language that is inadequate for the planned permanent discontinuation, and would require a completely different remediation logic. In addition, every stakeholder involved needs to be notified of potential changes as part of the transition.
Enterprises will find themselves left with two choices: significantly increase OPEX to scale up the internal legal team or outsource to specialist firms; or embrace technology to automate large swathes of the transition process.
Technology’s role in the transition process
The transition is going to be time- and cost-intensive for enterprises that rely on legacy tools and manual processes. As a result, the technology-led option is the clear winner. Machines are fundamentally faster and more accurate at ‘reading’ contracts and identifying the ones with LIBOR exposure. Plenty of AI-based solutions in the market claim to extract contract data but it’s only one piece of the LIBOR transition puzzle. Such document abstraction solutions need to be supported by a host of other point solutions for: migrating legacy contracts from other enterprise systems and storing them in a centralized repository; prebuilt data models and decision trees to determine the applicable remediation logic; reaching out to stakeholders en masse to communicate changes; and finally, an authoring tool to negotiate and implement new terms and ARR.
But ultimately the transition process isn’t going to be seamless if enterprises resort to an ecosystem of disjointed solutions. That’s why Contract Lifecycle Management (CLM) technology is uniquely positioned to play a crucial role in this process. Organizations will significantly benefit from leveraging a modern CLM platform that ties together all these capabilities and provides the necessary workflow and e-signature capabilities to close the contract remediation loop. Having a single platform to drive the entire LIBOR transition will enormously simplify the process and offer unprecedented efficiency gains.
The graphic below illustrates the various activities that AI-powered CLM technology can automate during the LIBOR transition process:
From a regional context, it is important for Indian financial institutions to be aware of how their global counterparts are responding to LIBOR challenges. For e.g., Indian enterprises with a portfolio of financial instruments based on MIFOR (Mumbai Interbank Forward Outright Rate) – which takes LIBOR as one of the components – are also going to be affected. Agreements for these would have to be updated with an ARR by the time the LIBOR phaseout is completed by Dec 2021. This will require an exercise similar to the one undertaken for the LIBOR transition. Hence Indian firms should take note of the best practices undertaken by global financial institutions and law firms.
If you have an interesting article / experience / case study to share, please get in touch with us at [email protected]