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25 August 2020
Transfer Pricing webinar:(L)IBOR Transition and Intra-Group Financing – Transfer Pricing Aspects of an Unprecedented Transformation
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Greetings and introductions
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G E O R G Y G A L U MO V X A V I E R T I N G U E L Y
S A L I M D A M J I
P E T E R N O B S
With you today
Partner, Transfer Pricing and Value Chain Alignment
at Deloitte Switzerland
Deputy Head Group Tax, Julius Bär Group
T H O M A S H U G
Director, Transfer Pricing and Value Chain Alignment
at Deloitte Switzerland
Director, Treasury & Debt Advisory at Deloitte
Switzerland
Manager, Transfer Pricing and Value Chain Alignment
at Deloitte Switzerland
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Agenda
Industry perspective5 22
Focus on key transfer pricing implications4 18
Main aspects of the (L)IBOR transition2 7
Greetings and introductions1 4
Q&A and closing6 23
Overview of treasury and commercial considerations3 15
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Main aspects of the (L)IBOR transition
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What are (L)IBORs?
What are
(L)IBORs
(L)IBORs are benchmarks interest rate at which major global banks lend to one another in the international interbank market for short-term loans
• Published on a daily base for tenors ranging from overnight to 12 months
• Calculated by averaging panel banks submissions
• Include both the expected cost of lending funds and the interbank credit risk (i.e. they are quoted on an “unsecured” base)
Major (L)IBORs
The major (L)IBORs are
• LIBOR – London Interbank Offered Rate – published for USD, EUR, GPB, CHF and JPY / administered by ICE and regulated by the FCA
• Euribor – Euro Interbank Offered Rate – published for EUR / administered by EMMI
• TIBOR – Tokyo Interbank Offered Rate – published for EUR / administered by EMMI
There are (L)IBORs across other currencies, but the bulk of the volume leverages the above reference rates
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Who uses (L)IBORs and what for?
Who uses
(L)IBORs
(L)IBORs are one of the most used benchmark globally, there is an estimated USD 350tn of financial products linked to (L)IBORs
• Main categories of products: Loans, Bonds (FRNs), Derivatives (e.g. IRS), Structured Products
• All industries impacted: Banks, Asset Managers, Corporates, supranational entities
What are
(L)IBORs used for
They are broadly used across institutions
• To price products;
• As discounting factor to value assets (e.g. collateral);
• As benchmark performance; or
• In treasury/risk processes/intercompany agreements (e.g. FTP)
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Why change?
In the aftermath of the 2007-08 financial crisis, it became apparent that these reference rates are inadequate due to their lack of robustness
Decline in liquidity
Reluctance from Panel Banks to submit quotes
Scandals related to alleged manipulations
In 2017, the FCA announced that due to insufficient meaningful data to sustain the LIBOR rate, the benchmark will be discontinued at the end of 2021
By end of 2021, FCA will not compel banks to contribute to LIBOR
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The (L)IBOR transition will not be a simple rate replacement transition
Current state
• Same administrator (ICE) across main currencies (EMMI in case of EURIBOR)
Future state
• Different administrators across the different currencies (e.g. SIX for SARON, The Fed for SOFR)
• Reference rate different across different currencies, with likely different standards, leading to operational challenges
Impact
Decentralised
governance
Structural
changes
Economic
changes
• Term rates published on a daily basis for 7 tenors (from overnight to 12 months)
• IBOR (and EURIBOR) published on an unsecured basis, i.e. inclusion of credit risk in values
• Benchmarks are overnight rates
• Plan for some currencies to publish term rates based on derivatives markets (OIS, futures)
• Secured or unsecured depending on the currency
• Absence of term rate with potentially strong impact on pricing methodology
• Clear communication internally and toward clients to mitigate conduct risk
• Transition with spread adjustment required for CHF and USD
• Transition likely with winners and loser
Three key changes leading to operational, structural and economic challenges that need to be addressed to avoid top- and bottom-line impact
Key changes
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New benchmarks have been determined, but only exist for “overnight”
Replacement rates are currently being defined by the different National Working Groups, decentralised governance leading to operational challenges
LIBOR (today) GBPUSD EUR CHF JPY
Benchmark
(overnight only)LIBOR SONIAESTERSOFR SARON TONAR
National
Working Group
(NWG)
N.a.WG on Sterling Risk-
Free Reference Rates
Alternative
Reference Rates
Committee (ARRC)
WG on Risk-Free
Reference Rates for
the Euro Area
NWG on CHF
Study Group on
Risk-Free Reference
Rates
Term Rate YesPlanned, Q1 2020,
likely based on OIS
Planned, end-2021,
based on OIS
No release date
know, but probably
based on OIS
Not recommendedPlanned, mid-2021,
likely based on OIS
Secured /
UnsecuredUnsecured UnsecuredSecured Unsecured Secured Unsecured
AdministratorIntercontinental
Exchange (ICE)Bank of England
Federal Reserve
Bank of New York
European Central
BankSIX Swiss Exchange Bank of Japan
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New reference rates will be structurally different, in particular SARON
SARON will only be published as an overnight rate, structurally changing the way the market operates today – will price of products only be known at the end of the period?
Impact on
Products
From the market
LIBOR
(Current environment)
SARON
(Future environment)
O/N 1w 1m 2m 3m 6m
Today 3m
LIBOR fixing(Forward-looking)
• LIBOR is published daily for 7 tenors, allowing to know the pricing for a period at the beginning of the period
• Client does not have uncertainty during the period
• SARON only published on an overnight basis
• Period pricing only known at the end of the period by compounding the daily overnights rates
• Client takes on market risk during the period
12m
Key
Considerations
O/N
Toady 3m
Continuously compounded(Backward-looking)
Different options discussed at
the NWG (incl. forward-looking
options) – see next slide
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New reference rates will be economically different, in particular SARON and SOFR
SARON/SOFR are quoted as secured rated (LIBOR is unsecured), there will therefore be a transition spread – depending on the period considered, the spread will be different
• LIBOR is quoted on an unsecure base, while SARON/SOFR are on a secured one
• This implies that there is a credit risk spread between the old and new benchmarks
• The spread between SARON and LIBOR tends to increase during periods of financial turmoil (e.g. 2007-2008), when credit risk is high
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SARON-LIBOR Spread (monthly average)
LIBOR 3M (CHF) LIBOR ON (CHF) SARON
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Overview of treasury and commercial considerations
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Focus on five key topics
What needs to be done before (L)IBOR is terminated by 2021
Fallback Language Identify contracts with duration longer than 2021 Review contracts around trigger event, fallback rate and fallback spread
FX / IR program Identify implications to FX / IR hedging programDefine tactical changes needed now for existing products
Define long-term strategy
AccountingIdentify hedge accounting of interest rate cash flows and instrument valuation techniques based on (L)IBOR
Review possibilities of applying IFRS 9 and IAS 39 relief from the effects of (L)IBOR reform on prospective assessment
TaxesReview impacts from changes in FV as well as transfer pricing agreements incl. LIBOR references
Define measures to avoid changes to financial instruments which could trigger tax events
IT InfrastructureIdentifying systems using (L)IBOR (e.g. yield curves)
Define program architecture and capabilities versus requirements
Impact Analysis Solution Design
• Establishing the scenarios and assumptions• Defining the scope, methodology, tooling and Technology• Gathering and analysing the inputs and data needed to complete the
assessment
• Prepare programme plan including activities, timings, resource, costs and delivery risks
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Define reporting structure to control FX P&L impact of new vs. old IC loan structure
Implement Treasury analytics and reporting
Project successful implemented
Design FX translation hedging structure adapted to your restructured IC loan portfolio
Implement structure (legal, tax and Treasury/FX aspects)
Operate new IC loan FX optimisation structure
Contractual changes according to (L)IBOR transition
Adjust new currency and interest conditions
Impact analysis on changes in FX P&L
Detailed analysis of current IC loan portfolio on FX p&l impact
Analyse local and consolidated impact
Prove IC loan translation impact minimisation
Prepare to group IC loan portfolio to define
Analysis of FX P&L Impact
Redesign IC Loan portfolio
Adapt Hedging Structure
Reporting FX P&L offset
Focus on optimisation of IC loan portfolio and FX translation P&L impact minimisation
What can be done in addition during (L)IBOR transition
• Besides (L)IBOR aspects
focus on FX translation
impacts on local and
group (consolidation)
level
• Use contractual
adaptations to verify a
restructuring of IC loan
portfolio by grouping
loans by few currencies
• Implement FX
translation hedging
structure to offset FX
P&L impact from IC
loans
• Implement reporting to
permanently control
impact
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Focus on key transfer pricing implications
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Main implications from a tax & transfer pricing perspective (I/II)
From a tax & transfer pricing perspective, the IBOR transition and the resulting implications are underpinned by the existing transferpricing rules relating to intra-group dealings:
OECD Guidelines
As per chapter IX of the OECD Transfer Pricing Guidelines for Multinational Enterprises and TaxAdministrations, the termination and/or substantial renegotiation of existing arrangements maybe perceived as business restructuring and may have to be compensated at arm’s length if suchtermination and/or substantial renegotiation would be compensated between independent parties incomparable circumstances.
In addition to this, on 11 February 2020, the OECD issued the final version of the Transfer PricingGuidance on Financial Transactions (the “FT Guidance”). The guidance covers the following:
• Accurate delineation of financial transactions
• Treasury function:
o Treasury centre services
o Intra-group loans
o Passive association
o Cash pooling
o Hedging
• Guarantees
• Captive insurance
• Risk-free and risk-adjusted rates of return
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Main implications from a tax & transfer pricing perspective (II/II)
From a tax & transfer pricing perspective, the IBOR transition and the resulting amendments to existing contracts or valuations mayresult in significant tax & transfer pricing issues:
As a consequence, before amending existing contracts (e.g. loans, derivatives), companies shouldconsider whether this could:
• give rise to a disposal of the existing contract for tax & transfer pricing purposes;
• result in step ups/downs of the principal mounts under consideration;
• require one-off payments in relation to the changes;
• impact the effective margins applied to the arrangements under consideration.
Long-term funding contracts based on IBOR (which extend beyond 2021) should already take thetransition into account.
Where intra-group IBOR funding is being replaced or novated, companies should check that the newmethod of pricing is on arm’s length basis in accordance with transfer pricing rules, so as to ensure thereare no tax return adjustments to deny the deductibility of financing expenses.
Implications
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How to ensure a seamless (L)IBOR transition from a tax & transfer pricing perspective?
Ensuring a seamless (L)IBOR transition requires a holistic approach covering all aspects of the transition:
Evaluation of the tax & transfer pricing risks related to the arrangements impacted by the IBOR transitionand definition of a transition roadmap to mitigate these risks.
Exposure
assessmentIdentification and review of arrangements potentially impacted by the IBOR transition from a tax & transferpricing perspective.
Risk
mitigation
Implementation support to ensure a compliant IBOR transition from a tax & transfer pricing perspectiveincluding transfer pricing documentation and contract remediation.
Operational
readiness
Knowledge sharing
and learning
Development of an understanding for the IBOR transition and its implications, the differences between IBORsand ARRs, and how other companies are organized to handle this transformation from a tax & transferpricing perspective.
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Industry perspective
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Questions?
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Thank you for joining us and see
you next time!
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