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Non-Banking Finance Companies (NBFCs) in India need to plan for an effective Inter Bank Offered Rate (IBOR) transition, as majority of LIBOR rates are likely to be phased out by the end of 2021, a new EY India report has suggested.
London Inter Bank Offered Rate (LIBOR) is one of the most common series of benchmark rates referenced by contracts measured in trillions of dollars across global currencies.
About $350 trillion worth of contracts across the globe are pegged to LIBOR, which is the key interest rate benchmark for several major currencies.
Some of the leading banks in India have also embarked on the journey to assess the impact of LIBOR cessation on their balance sheets and operations, according to EY India report, ‘Impact of IBOR transition on NBFCs in India’.
Key challenges
The report underpins the key challenges that will need to be addressed by NBFCs, banks and other institutions with respect to contract amendments, financial reporting, tax and other risks due to cessation of LIBOR rates after 2021.
NBFCs cannot remain detached from this transition as it is equally important for them to inventorise their LIBOR-linked borrowings and derivative exposures and develop a proactive roadmap to assess the impact on their financial statements, bottom line and their ability to raise overseas borrowings at a competitive rate.
Sandip Khetan, Partner and National Leader, Financial Accounting Advisory Services (FAAS), EY India, said in a statement: “This is an opportune time for NBFCs to develop LIBOR transition plans and proactively communicate with regulators, investors, lenders, customers and other counterparties. This will invariably enable NBFCs to proactively engage with their corporate clients who will also be impacted by LIBOR migration on account of their sizeable overseas borrowings and derivative exposures.”
NBFCs with exposures to interest rate derivatives and foreign currency borrowings linked to LIBOR need to be mindful of transition to Alternative Reference Rates (ARR), also known as Risk free rates (RFR). There is an estimated overseas foreign currency borrowings of $13 billion and notional derivative exposure covering forward rate agreements, interest rate swaps and cross currency swaps to the tune of $18 billion across the top 10 NBFCs.
It is imperative for NBFCs to understand what it means to link their forex borrowings and derivative transactions to Secured Overnight financing rate (SOFR), Sterling Overnight Interbank Average Rate (SONIA), or other comparable RFR benchmark interest rates.
MIFOR
Incidentally, the Mumbai Interbank Forward Offer Rate (MIFOR), widely used by banks in India for setting prices on forward rate agreement and derivatives, has USD LIBOR as its core component. This may now be linked with SOFR, the ARR used for US dollar denominated derivatives and loans.
NBFCs may need to examine their legacy contracts linked to LIBOR and understand hedging and other implications on new contracts that may be linked with SOFR or any other comparable benchmark rates.
An early impact assessment will help NBFCs understand the problem statement and respond ahead of time, if it means repapering the contracts or aligning its wider treasury and hedging objectives on foreign currency loans hedged with derivatives, according to the EY India report.
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