With no clear candidate to replace U.S.-dollar LIBOR when the benchmark is eventually discontinued, market disruption remains a risk, says Fitch Ratings.
While most forms of LIBOR are slated to be discontinued by the end of the year, U.S. LIBOR has been given an extension until June 30, 2023.
In a new report, the rating agency said the slow transition away from the U.S.-dollar edition of the benchmark, with multiple possible alternative rates, “may increase disruption risk for banks and certain structured finance issuers at the start of 2022.”
Fitch said most large financial institutions are likely to adopt the Secured Overnight Financing Rate (SOFR) as a replacement, but that choice isn’t unanimous and the U.S. dollar debt market “appears destined toward a multi-rate environment.”
This uncertainty may mean that new derivative and bond issuance occurs in a compressed time period near the end of the year, the report said.
“The switch en masse away from US LIBOR without a clear successor may lead to increased rate/market volatility,” it said.
Additionally, financial institutions will face larger risk management challenges as they “will need to determine appropriate hedging for a patchwork of rates,” it said.
The uncertainty may also curb market liquidity “as investors perhaps pause new issuance or try different rates until there is consensus.”