As well as ringing in the start of a hopefully brighter and better 2021, January also saw Indian banks testing the waters of LIBOR transition, with State Bank of India and ICICI Bank involved in their first alternative risk free rate transactions. Utilising the US dollar Secured Overnight Financing Rate (SOFR), these deals signal that the Indian market is at last receptive to the prospect of LIBOR transition, having been initially slower to react than other markets.
The 2021 deadline for the cessation of LIBOR dates back to 2017 when the Financial Conduct Authority commenced the discontinuation process, pledging not to compel panel banks to publish LIBOR beyond the end of 2021. Despite the impact of the COVID-19 pandemic which initially appeared as though it may cause the regulators to extend the status quo, the financial repercussions of the crisis have only served to reinforce the inadequacies of LIBOR, providing momentum to the replacement process globally. That said, the scale of the transition, particularly in the US dollar market is huge and, in recognition of the enormity of the task facing banks, the transition deadline for certain dollar LIBOR rates has been pushed back to mid-2023.
The LIBOR transition process in India has been driven largely by the Reserve Bank of India (RBI) and the impetus and encouragement it has provided to the process. The RBI constituted its Financial Benchmarks Committee in June 2013, in an attempt to review and retain the integrity of the Indian financial benchmark system in the context of the extensive cases of LIBOR manipulation. In June 2019, the RBI introduced a regulatory framework for financial benchmark administrators to create an acceptable and consistent standard of benchmark calculation. Following this, a "Dear CEO" letter was circulated in August 2020, communicating to all commercial banks the need for stakeholders to prepare for LIBOR's cessation. The pressure on commercial banks increased in November 2020 when the RBI's bulletin for that month built upon its previous messaging, further increasing market participants awareness of the need for a proactive approach to address LIBOR discontinuation.
Coming around the time of Diwali, the Hindu festival of lights, the November bulletin was an unexpected firework from the RBI, which lit up the financial sky in India in late 2020. In this bulletin, the RBI laid bare the extent to which progress still had to be made on LIBOR transition and estimated that India's LIBOR exposure amounted to $331 billion, warning institutions that they only had just over a year to implement their transition plans. In this short timeframe, banks have been tasked with identifying exposures, determining the associated risks, and taking steps to complete the transition process. The link between LIBOR and the Indian economy is profound; the Mumbai Interbank Forward Offer Rate (MIFOR) is calculated using USD LIBOR, as are commercial borrowings, derivatives, government loans and trade contracts. The conversion process will be complex, as evidenced by the challenges currently being faced by other markets which are further forward in their transition journey.
Other economies have established networks of working groups and committees to investigate and recommend alternative risk free rates (RFRs), to replace LIBOR and to advise on managing the transition process. Following this direction, the Indian Banks' Association (IBA) has formed a LIBOR working group, dedicated to recognising and measuring the impact of LIBOR's cessation on the Indian markets. Modelled on the approach adopted by the UK and US regulators and trade associations, the working group is raising awareness of the process and issues through a series of webinars and conferences. Its review has revealed that contractual fallback clauses facilitating the continuation of contracts despite the discontinuance of LIBOR are largely absent or, where present, insufficient. This further highlights that the existing fallback language will often be highly bespoke to the Indian market, requiring further development to meet the global standards and practices that have evolved in other economies.
These recent initial SOFR based transactions from Indian banks are an important first step in testing the infrastructure required to support India's LIBOR transition, signalling that the Indian market has moved on from discussion and consultation to commence the implementation phase. However, despite this promising start, it is clear that developing internal approaches and strategies to replace a fundamentally entrenched benchmark will be a complicated process with far reaching ramifications, and that India still has a way to travel on its journey to adopting replacement RFRs. Guidance has been circulated to assist member banks in the assessment of accounting, tax and IT capabilities necessary for the transition. The Indian economy, like all economies globally, will require a substantial element of re-engineering to prepare IT systems, reporting, risk management and internal governance for LIBOR's cessation as differing RFR publication timings, and pricing are built into the systems and processes of Indian banks.
At present, not all the future steps on India's LIBOR transition journey are clear, with the IBA still working towards developing an acceptable MIFOR alternative rate. Having witnessed other economies grapple with settling on an alternative replacement RFR, the proposed replacement needs finalising and publishing imminently to enable stakeholders to act and implement it. In addition, the challenge of amending existing transactions that reference LIBOR and the tough legacy contracts that this process will undoubtedly expose, are largely uncharted territory for Indian markets. Experience of this process in other economies has demonstrated that time is required to identify tough legacy contracts and plan on how to deal with them, work on amendments and devise guidance on how to approach them. However, with the clock ticking, time is a luxury that the Indian market does not have.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.