For banks saying goodbye to LIBOR won't be easy, but artificial intelligence can help

LIBOR expires in 2021 and banks face an uphill struggle to change all their existing contracts

LIBOR (London Interbank Offering Rate), the interest rate used as a benchmark for trillions of pounds-worth of loans globally, is set to expire in 2021. What will become of the hundreds of millions of financial contracts around the world that reference LIBOR? How will companies minimise the legal and financial risk to which contracts maturing after 2021 exposes them? With the phase-out of LIBOR right around the corner, the time to prepare is now. And artificial intelligence (AI) can help.

Preparing for LIBOR retirement

The transition away from LIBOR requires three critical steps:

1. Understanding the contract landscape

Banks must first review all contracts maturing after 2021 to assess whether and how they will be impacted by the LIBOR transition. This is no small feat. This complex analysis requires deep domain expertise and understanding of asset classes. For example, a fixed-rate loan contract that is ostensibly not linked to LIBOR may contain an interest rate derivative linked to it. Banks must develop a set of contract review questions that address all of the complexities.

2. Incorporating interim amendments

To date, a replacement rate has not yet been identified. But banks must start now to incorporate interim amendments. For example, if there are loans that do not have any fallback language, contract terms in case LIBOR is unavailable, banks can incorporate a soft fallback option. Banks can also start to develop contingencies. For example, LIBOR serves seven different maturities (overnight, one week, and 1, 2, 3, 6 and 12 months). However, the replacement rate might not mimic the same tenor structure, so banks can plan for contract changes that should be implemented in this case.

3. Replacing and implementing the new rate

Once LIBOR's successor has been identified, banks must amend contracts, update systems and processes to procure and test data feeds for the new rate, and train staff to address the needs of the new rate.

The solution of man and machine

With a human workforce alone, such an undertaking would hardly be possible. However, artificial intelligence (AI) can provide first-mover advantage by supplementing the human workforce to assess and review existing contracts.

In fact, AI solutions are already being applied to interpret tens of thousands of agreements and amendments across industries. These same solutions may now be applied to the LIBOR transition.

Using applied computational linguistics, pattern recognition, and machine learning, AI can extract contract terms and validate them against the contract review questions and other data. For example, AI, specifically natural language understanding, can identify whether LIBOR is being referenced in the loan and direct humans to the exact locations in the loan documentation that cites LIBOR.

Using machine learning, AI can learn to identify the numerous permutations of phrases that cover fallback procedures and whether they are sufficient for the permanent discontinuation of LIBOR. And AI can validate that the amendments processed are reconciling with the guidelines given by the front-office.

The benefits of using AI to manage the transition

According to the second edition of Genpact's recent research on AI, the banking sector stands out as the top spender in AI technology, but is only average in achieving very positive outcomes from AI. This may be because banks are not leveraging or using it in the right way. Applying AI to the LIBOR transition is an ideal way for banks to harness the technology's power to drive positive outcomes. An AI solution to the LIBOR transition affords:

• Traceability - AI makes archival data available so banks can see what changes have been made to their contracts, creating an audit trail.
• Complex interpretations - A combination of deep expertise in commercial lending and AI helps banks interpret the context of various LIBOR references and the legal aspects of the contract.
• Accuracy - AI minimises the risk of human error and allows banks to run rules to catch any mistakes that do occur
• Scale - AI can supplement the human workforce to assess and review existing contracts.
• Opportunity - AI can do more than address immediate LIBOR issues. For example, banks can use AI to mine loan agreements to assess and improve the degree of covenant protection available across their portfolio.

The clock is ticking

The transition from LIBOR to an alternative rate has the potential to cause havoc if not handled properly. "The biggest obstacle to a smooth transition is inertia," said Andrew Bailey, CEO of the UK's Financial Conduct Authority, publisher of the rate.

AI can help financial institutions get moving to manage the legal risk associated with the LIBOR transition. With AI and the right partner, they can turn struggle into strength, challenge into opportunity.

Anu Sachdeva is the global service line leader for commercial banking at Genpact