Alexandre Hardouin, Director of Fixed Income Desktop at Refinitiv spoke to Best Execution about the progress being made in the Libor transition process and the challenges to be met in this complex environment.
What is the current state of play?
There is a split between the US and UK, and you can see this from the liquidity figures. Sonia (Sterling Overnight Index Average) is a more mature and well-established, alternative risk-free rate (RFR) and we are seeing liquidity across the board in the basis swaps, cross-currency swaps, swaptions, cap/floors and the more complex deals. In the UK, all new sterling bond issues in FRNs and most securitisations have been referencing Sonia since June 2018. On September 29, 2021, the Financial Conduct Authority (FCA) announced that it will compel IBA to continue publishing one-, three- and six-month sterling and yen Libor rates in synthetic form from January 4, 2022. The UK regulator will also decide and specify before year-end which legacy contracts are permitted to use these non-representative, synthetic Libor rates for at least a year.
By contrast, Sofr (The Secured Overnight Financing Rate) has been created specifically for the transition and although liquidity is increasing and we have seen record high trade counts and volumes with the release of the ‘Sofr First’ initiative (in which interdealer brokers replaced trading of Libor linear swaps with Sofr linear swaps from July 26 this year), the total notional USD Libor continues to dominate markets. This may change as we have moved from phase 1 to phase 2 and we anticipate trading to rise. The RFR adoption in futures and derivatives is an upward trend in trading volumes since Sofr First. It is interesting to note that, on the cash market in September, FRN issuance, based on US dollar Libor, recorded its lowest monthly total and more new issues have been done on Sofr than on Libor.
Market participants in the US also have more time to prepare because regulators have said that while the deadline for most Libor rates (including one-week and two-month US dollar will be made on Dec. 31, 2021, the long-dated contracts will have until June 30, 2023, to make the switch.
What about in Europe?
As for the euro short-term rate (€STR), activity overall has been limited and the markets continue to rely on Euribor and EONIA. One reason take-up may be low is that there has not been the same regulatory push from the European Central Bank as there has been from the Bank of England. Recently the Euro working group launched an €STR first initiative, e.g. a recommendation for interdealer brokers to switch from EONIA to €STR at a common date set to Monday 18th October.
There are different benchmarks in the US. How do you see the landscape unfolding?
There are different, credit sensitive rates such as BSBY – Bloomberg’s Short Term Bank Yield index or Ameribor (American Interbank Offered Rate). There has been strong push-back from the SEC (Securities and Exchange Commission) as well as the UK’s FCA who said they do not want to see them used in the Libor transition. So far, we have not seen any pick-up or adoption of these credit-sensitive rates and Term Sofr is expected to be the main forward-looking term rate.
What level of preparedness are you seeing?
It depends on the size of the firm. The main difference with alternative RFRs is that they are based on overnight deposits that are backward looking, in contrast to Libor, which has six forward-looking tenors (plus one overnight rate) out to one year. Also, 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.
What we are seeing is that large banks and corporates in Europe operating in the derivatives markets seem to be ready and have implemented a multi-rate environment. However, that is not the case with smaller banks and corporates. They are starting the process and looking across cross currencies, swaps and loans to identify exposures to understand where they should implement the changes. However, they will need to do more work in the back office to deal with the changes such as upgrading their systems, processes and technology for the move away from a term structure. They will also need new market data sets to value new Risk-Free Rates derivatives such as new Zero curves.
In general, how can firms prepare for the upcoming Libor Transition?
A good starting point is to develop an understanding of the organisation’s exposure to Libor and the different workflows, processes and applications that it was using. This means market participants have to go through data on benchmarks, fixings and derivatives data such as OIS or overnight index, basis swaps and cross-currency basis swaps, swaptions and caps/floors as well as the Sonia and Sofr term rates that are being used.
The other important piece of data that is needed is on ISDA Fallback which provides market participants with a mechanism to amend their existing derivatives contracts as well as other specified documents which reference in-scope Ibor rates to include the updated rates and fallbacks. Market participants will need to review documentation to identify fallback clauses.
However, it is not just about looking at exposures and ensuring you have the right market data. It is also important to be able to do the necessary calculations on cashflows, spread adjustment rate and compounding in arrears (this is a methodology that compounds daily values of the overnight rate throughout the relevant term period). It differs from a typical term rate by calculating interest looking backwards and as a result it includes a brief period in advance of payment to set the interest rate and calculate payment. As a vendor we provide new Risk-Free Rates Zero curves and Analytics APIs.
What are the challenges?
It is a new environment, and it has become a full time job to keep pace with all the different announcements, recommendations, working groups and information. There seems to be something new coming out every week. What is clear though is that by the end of 2021, there will be a complete disintermediation of GBP, CHF and JPY Libor and firms need to have their systems, processes and data in place.
What are some of the solutions?
At Refinitiv, an LSEG (London Stock Exchange Group) business, we have a desktop-based open platform that is used by over 9,000 fixed income trading users around the world which provides a range of real-time data feeds, tools and analytics for all markets. We also have made fallback provisions for FRNs available across our products and services, have added fields and index transition details identifiers in our databases, and enhanced our search capabilities enabling users to find market data and fallback easily.
©Markets Media Europe 2021
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