States review loan contracts ahead of Libor's end

Thursday July 08 2021
The Central Bank of Kenya.

The Central Bank of Kenya. PHOTO | FILE | NMG


After “scandal” of 2011, of widespread allegations of manipulation, it became evident the Libor global benchmark rate had been fiddled with for years.

Kenya is reviewing its loan contracts ahead of the cessation of the London Interbank Offered Rate (Libor) to align them with the new risk-free rates, The EastAfrican has learnt.

The government is already negotiating with sovereign bondholders, commercial bank, and other bilateral and multilateral creditors to agree on the repricing of more than $36 billion worth of external loans to cushion against a possible surge in interest rates from January 1, 2022, after the phase-out of the global benchmark rate used in determining the cost of loans.

Libor, introduced in 1969 and formalised in 1986, is set to be phased out on December 31, 2021, amid uncertainty around its possible replacement. The benchmark was meant to show average interest rate at which selected banks — so-called Panel Banks — would be willing to grant unsecured loans to one another. It is used as the base or reference interest rate in financial contracts.

But after the big “Libor scandal” of 2011, following widespread allegations of Libor manipulation, it became evident that the benchmark had been fiddled with for years. This led to a full-blown inquiry, and the UK Financial Conduct Authority, which oversees global benchmarks, announced in 2017 that use of the Libor would end on December 31, 2021 for the sterling, the euro, Swiss franc, and the Japanese yen.

Liquidity premium


While alternative reference interest rates have been developed at a national level in the run-up to December 31, there is still no global consensus on the replacement for the Libor, partly due to the fact that the alternative risk-free rates (RFRs) are currency and jurisdictional-specific and global coordination has not been very strong.

These alternative rates include the Swiss Average Rate Overnight (Saron) in Switzerland, Secured Overnight Financing Rate (SOFR) in the US and the Sterling Overnight Interbank Average Rate (Sonia) in the UK. It is argued that SOFR and Sonia stand out as top contenders for the new benchmark rate and are likely to be lower than the Libor, as they do not factor in credit risks and the term liquidity premium.

In Nairobi, Treasury Director of Debt Management Dr Haron Sirma confirmed this week that they are “actively discussing, evaluating variable interest rates for loan contracts with creditors ahead of cessation date of publication of Libor and replacement with the equivalent Risk-Free Rates and manage the risk and accounting issues arising thereof.”

Dr Sirma said currency markets are reacting continually to the news of the transition and “minimal adjustment in costs of floating rate debt is expected.”

Adjusting repayments

The Tanzania and Uganda economies, have at least $24 billion and $12 billion of foreign debt respectively to renegotiate before December 31, according to figures from their central banks.

Kenya has over Ksh400 billion ($3.7 billion) worth of foreign debt repayments to make during the 2021/2022 fiscal year, comprising Ksh138.36 billion ($1.28 billion) and Ksh262.09 billion ($2.4 billion) of foreign debt interest payment and foreign debt principal repayment respectively.

In April this year, Kenya’s cumulative debt service to bilateral creditors accounted for 25.38 percent of the total debt servicing while commercial and multilateral creditors accounted for 57.99 percent and 16.63 percent respectively, according to figures from the National Treasury. The government paid Ksh80.2 billion ($743 million) in foreign debt interest for the nine months to March 31, 2021.

Daniel Kuyoh, a Nairobi-based financial analyst, says that interest payments will shift in the next year as lenders adjust to the new guidelines.

“They (interest payments) could adjust either way,” he said.

The State Bank of Mauritius (SBM) has already warned that the Libor exposure on its Mauritian and Kenyan operations is “significant” and the bank is facing material impact in terms of fair value changes on financial instruments and loss or gain in interest income.

“The major risk in this area (interest-rate risk) is the uncertainty on the new risk-free rates and spreads which will replace Libor on December 31, 2021 and June 30, 2023. The Group has already started work on an impact assessment and the way forward at entity level,” SBM said in its 2020 annual report.

“For SBM, the Libor exposure is significant and impact will potentially be material in terms of fair value changes on financial instruments and loss or gain in interest income,” the report said.

John Gachora, Group Chief Executive of NCBA Bank, says funding by development finance institutions in the East African market is often based on the Libor and some pricing realignment may occur, with the most quoted three and six-month USD Libor ceasing to be quoted in June 2023.

But the impact of the transition will be high in markets that have high volumes of hedging solutions in cash and derivatives instruments.

“These instruments are less present in East African markets and hence the impact of the Libor transition will be lower than in developed markets. Many customer advances in this market are on a variable rate basis as opposed to floating rate linked to the Libor reference, hence the expected lower impact levels,” Mr Gachora said.

Proposed replacement

Wycliffe Shamiah, Chief Executive of the Capital Markets Authority, said lenders switching to other indices could see higher base rates in the future, noting that the proposed replacements for the Libor are country-specific and will not allow for easy comparison between investments across borders.

“Libor was available in multiple currencies while its replacements are denominated in local currencies, which increases the exposure of investors to foreign-exchange swings. In addition, Libor replacements tend to have a smaller range of term-rate offerings,” said Mr Shamiah.

Others say that while it is disruptive, markets will manage the transition well as have known this was coming for a couple of years.

“Contracts have considered this change in the intervening period and market players have adjusted accordingly,” said Kihara Maina, Chief Executive of I&M Bank Kenya.

Experts at PricewaterhouseCoopers (PwC) say all contracts using Libor as reference rate will need to be identified and assessed for impact.

“Any contract that refers to Libor, whether apparent or hidden, will need to be carefully considered. Lenders should begin to develop an inventory of all contracts that could be affected including those outside of treasury functions,” the firm’s Ugandan consultants said in an April 2021 note titled How ready are you for phasing out of Libor?

According to PwC, Kenya has a strong pulse on the global finance and currencies market, with plenty of term rate based international currency flowing freely. As a result, the discontinuation of Libor could adversely affect several market participants in the country who hold Libor-referenced debt, including banks and other financial institutions, asset and fund managers, non-bank lenders and the even the government.

“The transition will pose significant tax, accounting, legal and administrative issues with potential cost implications. Doing nothing will create an operational crisis once LIBOR sees its sunset,” PwC said.