A new Refinitiv webinar sees a panel of experts analyse the plethora of challenges relating to the imminent LIBOR transition; unpack some recent developments; and discuss the best-practice solutions available to market participants.
- On 5 March 2021, the Financial Conduct Authority (FCA) announced immediately after 31 December 2021, 1-week and 2-month USD LIBOR settings will permanently cease and immediately after 30 June 2023, the remaining USD LIBOR tenors will either cease publication or become no longer be representative.
- LIBOR will need to be replaced with a series of alternative risk-free rates (RFRs).
- There are pockets of demand for term-rate versions of these RFR benchmarks that are being developed by benchmark administrators, including Refinitiv.
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The LIBOR transition is undoubtedly one of the most significant challenges that financial market participants have faced in many years.
LIBOR has a long history and has become ubiquitous within the financial system, which means that the imminent transition to RFRs presents market participants with a plethora of challenges, including how to price contracts; how to communicate the changes to customers; how to ensure that legacy exposure is minimised; and how to manage potential risk.
What is the timeline for the LIBOR transition?
On 5 March 5 2021, the Financial Conduct Authority (FCA) announced immediately after 31 December 31 2021, 1-week and 2-month USD LIBOR settings will permanently cease and immediately after 30 June 2023, the remaining USD LIBOR tenors will either cease publication or become no longer be representative.
While the 2023 deadline for the most widely used tenors offers the market some breathing room, panellists were clear that firms must not relax their efforts and should continue to forge ahead with their transition plans as supervisory guidance has called for no new USD LIBOR contracts after the end of 2021.
One of the key messages from our panellists is that we are now entering a period of rapid change. With just a few months to go before the key deadline of December 2021, firms need to ensure that they stay abreast of new developments and best-practice approaches to managing the transition.
The new RFRs differ from LIBOR rates in several ways. Alternative RFRs are based on overnight deposits and are backward looking, in contrast to LIBOR, which has six forward-looking tenors (plus one overnight rate) out to one year.
Moreover, RFRs are risk free or nearly risk free and transaction based, whereas LIBOR incorporates the credit risk of a typical panel bank and are submission or partly transaction based.
Two examples of RFRs include the Secured Overnight Financing Rate (SOFR), a rate that banks use to price U.S. dollar-denominated derivatives and loans. and the Sterling Overnight Indexed Average (SONIA), the overnight interest rate paid by banks for unsecured transactions in the British sterling market.
The legacy challenge in cash markets
The panel highlighted that the legacy challenge of the existing back book is often overlooked.
LIBOR formally came into existence in the mid-1980s, and for more than 30 years has dominated the interest rate market. As a result, many interest rate products in the USD, EUR, GBP, JPY and CHF currencies are likely to use LIBOR.
Recent estimates from the ARRC – a group of private-market participants convened by the Federal Reserve Board and the New York Fed to help ensure a successful transition from USD LIBOR to more robust reference rates – suggest that legacy exposures referencing USD LIBOR could be in the region of 220 trillion USD.
Although many of these instruments relate to derivatives or will have expired by June 2023, the market could still be left with roughly a 5 trillion USD exposure in USD LIBOR referencing cash products (e.g. loans, bonds and securitised products), and this constitutes a significant concern.
One of the key issues is that legacy LIBOR contracts may not have suitable fallback language that is able to cope with permanent USD LIBOR cessation. New LIBOR legislation recently signed into State of New York law reduces the adverse economic outcomes of legacy LIBOR fallback language.
Where the contract has no fallback or the fallback is based upon LIBOR, the law strikes out any existing language and replaces it with the ARRC’s recommended fallback language.
The ARRC has issued recommended fallback language specifying that contracts with that language would fall back to forms of the Secured Overnight Financing Rate (SOFR) plus a fixed spread adjustment at the point of transition for legacy contracts. The rates must take account of the nuances within different markets, for example, consumer versus institutional.
Challenges on the ground
During an online poll, the webinar audience was asked to select the main challenge they face with the LIBOR transition to alternative RFRs. Results showed that nearly half (48.4 percent) struggle with term rate availability; with a significant 29 percent saying that updating procedures and systems is their key challenge.
The panel went on to discuss the reasons why many respondents selected a lack of term rate availability, unpacking why some markets need term rates.
Two key issues are at play.
Firstly, many systems and processes require the benchmark to have a term structure. This is simply the way the market has evolved and has become the accepted convention. Moving away from a term structure will necessitate the enhancement of many systems, which can have time and cost implications.
Secondly, and perhaps more compellingly, is the fact that ultimately some products, for example within trade finance, cannot function without the concept of a term structure.
Panellists also concluded that corporates would welcome a term rate, as they would find it more similar to the LIBOR benchmark that they are used to.
Tangible help to navigate the LIBOR transition
Refinitiv has been developing a holistic suite of benchmarks, data, tools, analytics and support to help firms navigate the transition to alternative rates.
We are introducing new benchmarks such as Refinitiv Term SONIA (a forward-looking GBP risk free rate) and USD IBOR Cash Fallbacks, as well as upgrading our analytics and introducing new market data to take account of the full range of changes relating to the LIBOR transition.
We have developed a dedicated app within our Eikon solution. The IBOR Transition app allows users to keep up to date with global changes to interest rate benchmarks. It is updated regularly, and provides news and values on a variety of rates including RFRs; reformed IBOR benchmarks; incumbent interest rates; broker RFR derivative content and exchange RFR derivative content.
As the LIBOR transition deadline approaches, robust data and innovative tools such as these will deliver invaluable support to firms as they seek to maximise efficiency and minimise disruption in their day-to-day activities.