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End of LIBOR presents unique end of quarter payments test for corporate lending market 

$2 trillion syndicated loan market faces payment test using new interest calculation methodology at the end of Q1

In 1 weeks’ time the global lending market faces a test of just how robust and prepared its payment calculation engines are working in the new post LIBOR world. Banks and administrators around the world have been preparing for the LIBOR transition for over 2 years now, swelling the coffers of lawyers and consultants the world over. This quarter will see the first batch of loan interest payments being made post LIBOR cessation. The calculation methodology is wildly complex – especially for leveraged loans where $3bn of loans are traded every day, the more a loan is traded in an interest period the more complex the interest distribution ledger becomes.

Gone is the LIBOR benchmark that so ingloriously dragged the reputations of central banks through the mud in the financial crisis, resulted in huge fines and record jail sentences for abusive market practices on both a firm and individual level. This has now been replaced by a new breed of Risk-Free Rate “RFR” collected from a much larger cross section (1000’s) of transactions daily and therefore is deemed harder to manipulate. The old LIBOR setting was, if you remember, concentrated in the hands of a few key risk takers at large banks and therefor easier for an individual submission to influence the outcome. 

A new methodology for calculating interest

Loans are a floating rate product – that means they pay a margin of interest in addition to a benchmark. In the LIBOR days calculating interest for a loan was simple – 3 days before the start of an interest period a loan would “fix” its interest rate for the next period – typically 90 days. So, an administrator’s role involved taking the GBP or USD LIBOR rate on that date and adding the margin of interest. So, if the LIBOR rate was 0.5% and the margin was 3% administrators would apply this 3.5% rate uniformly across the 90 days.  Nice and simple. 

The steps above represent the NCCR Risk Free Rate determination for the traded loan market using SONIA

Non-Cumulative Compound Rates (NCCRs)

Quite frankly what it has been replaced with is beyond complex and only partially represented in the formulas above. This is further complicated by the fact that over $4bn of loans trade every day meaning that administrators need to calculate each lender’s share of a loan on a daily basis as the ownership of a loan is constantly changing. The interest is accrued daily and reconciled manually at the end of every quarter.

Loan administrators are now required to perform a set of calculations on a daily basis that involve a set of rules and observations that are fraught with potential danger, what if you only use 16 decimal place rather than 4 in when calculating your ACR, on the way to generating UCR then NCCR? The liability for banks and loan administrators is huge. 

The post trade ecosystem of large banks and money managers is in desperate need of automation and the space has not been without controversy in the past 2 years with notable high profile administration errors tarnishing the reputation of both Citi (Citi/Revlon $900mn admin error) and Barclays investment banking operations (Cineworld litigation around LIBOR floor errors).   

It will be a miracle if this series of payments passes without significant event. 

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