THERE IS NO TURNING THE CLOCK BACK NOW.
Alexandre Hardouin, Head of Rates at Refinitiv explains why market participants need to prepare now and the solutions that can help them navigate the Libor switchover.
What is the status on the Libor transition? The UK seems to be ahead of the US in preparations for the 31 December 2021 deadline.
One of the reasons that the UK seems to be ahead is that the manipulation of Libor happened in London and the Bank of England and Financial Conduct Authority have taken the lead. They decided to go with SONIA (Sterling Overnight Index Average) which is well established and already used as the underlying reference rate for OIS (overnight indexed swaps). Market participants know how it works, there is already a curve and there is liquidity. Refinitiv, Intercontinental Exchange and London Stock Exchange Group have also already launched indicative term SONIA rates to help the industry transition from Libor. This makes it a different magnitude of change than SOFR (the Secured Overnight Funding Rate) in the US or €STR (Euro Short-Term Rate) in Europe which are new.
What is happening in the US and Europe then?
The European Central Bank has not set clear guidance or a hard deadline for the transition as the Bank of England has. In the US, the Federal Reserve would like to follow the UK and develop a term structure prototype like the ones that have been built for SONIA – the term reference rate (TSRR) which is built on OIS and covers one, three, six and 12 months tenors on a daily basis. The Alternative Reference Rates Committee in the US recently released a Request for Proposals (RFP) looking for a potential administrator to publish forward-looking SOFR term rates. One of the problems with both benchmarks is that they are backward looking and there is a recognition that there needs to be a forward-looking term benchmark. This is particularly true for the cash markets for products such as loans, floating rate notes and securitisation
To date, what type of activity have you seen?
So far, we have more volumes in short term rather than long term products. However, LCH SwapAgent, recently registered its first SONIA/SOFR cross-currency basis swap, on behalf of Bank of America and Lloyds Bank Corporate Markets. We can anticipate that the notionals for such Basis Swaps trades on new Risk Free Rates will increase, and other Derivatives such as Caps Floors and Swaptions will also move to new Risk Free Rates.
Some people I have spoken to think SOFR will not be the only benchmark. Do you agree? Will it be American Interbank Offered Rate (Ameribor)?
I think that SOFR will remain the main benchmark because it is being pushed by central banks and regulators. It depends on market adoption, but we are already not only seeing SOFR cross currency swaps but also caps, floors and swaptions. The issue at heart is the term structures and backward-looking rate and if that is not resolved then some companies may use Ameribor.
How are you helping your clients?
We are getting a lot of questions, especially from tier 2 and 3 institutions who really want to understand how the transition will impact them. They are looking at their existing portfolio and what changes they will have to make. One of the biggest challenges is data. The way we approach the shift from Libor to RFRs is to provide clients with more information, data sets and tools to help them with the transition.
What are the key data sets and tools that can help them?
Last year, we created a dedicated App in Refinitiv Eikon called IBOR Transition which has links to ISDA (International Securities and Derivatives Association) and central bank working groups as well as news and values on RFRs, reformed IBOR benchmarks, interest rates and brokers RFR derivative content including fixing, OIS, basis swaps and forward rate agreements.
In terms of data, we provide alternative RFR data sets across all our product lines – Eikon, real-time feeds and DataScope. These include rates, term structures and compounded rates for 30, 60 and 90 days published by central banks. We will also offer fallback rates for ISDA OTC derivatives as well as market data on swaps, basis, caps and swaptions and zero curve replacements for existing Libor curves which can be accessed through OIS Zero.
We also offer a wide range of Libor data sets which market participants need to understand their exposure to Libor. These include existing data sets such as market data and curves, in addition to identifying IBOR exposure against securities and fallback language which describes the impact to the coupon in the event of Libor not being made available.
What type of tools are your clients looking for?
We are developing new and enhancing existing products and tools across our offering. These include the App as well as Search/Monitor which identifies new and existing bonds and derivatives linked to IBORs/RFRs. There is also DataScope, that for example, has new fields to identify Libor linked securities, calculators for using RFRs to price instruments and analytics such as curves, Libor-OIS spreads and bootstrapped OIS curves for discounting and projecting cashflows.
What do you see as the next milestone for the firm?
We launched our prototype Term SONIA Reference Rate in July in one, three, six-month tenors and in September added 12 months. We used a waterfall methodology that calculates a mid-price based on clearing a pre-determined notional amount. The secondary source of data is OIS streaming bids and offers from Tradeweb’s institutional electronic swaps platform. We will release a compounded realised rates calculator in the coming weeks.
Has Covid slowed down preparations?
Covid has had an impact on banks, institutions and corporates because they have had so many other things to deal with and they may have been ready earlier for the Libor transition if the pandemic did not happen. However, although there have been some delays, we have not seen any changes to the hard deadline of the end of 2021. The Bank of England made it clear quite early in April that they intended to stick to the date.
What are the biggest challenges?
One of the biggest challenges is the legacy contracts on swaps, cross currency, caps and floors and swaptions. There are around $340 trillion legacy contracts and there is a lot of focus on having fallbacks in place that allow for a smooth transition. ISDA has done a lot of work on revising fallback language and protocols for bonds and derivatives. It recently published IBOR Fallbacks Protocol and IBOR Fallbacks Supplement which aims to help counterparties amend legacy contracts whose fallback provisions do not account for a permanent end to the referenced IBOR. As mentioned, we are adjusting these amended fallbacks into our solutions, analytics and existing data.