Insight: The LIBOR Transition
LIBOR’s administrator, ICE Benchmark Administration (IBA), has published a consultation, which ended on 25 January, on its intention to cease publication of LIBOR:
- On 30-Jun-2023 for the most popular USD LIBOR tenors: overnight, 1M, 3M, 6M & 12M,
- On 31-Dec-2021 for all other currencies’ settings as well as 1W & 2M USD LIBOR.
Shortly thereafter, we expect that LIBOR’s regulator, the UK’s Financial Conduct Authority (FCA), will announce that LIBOR settings will be non-representative as of the dates above. Regulators globally, and crucially in the US, have stated that they will not allow new use of USD LIBOR after the end of 2021.
The extension of USD LIBOR’s key tenors is about legacy and does not fundamentally shift a transition project’s timelines. Indeed, more USD exposures will roll off before the new discontinuation date. However, for new products, asset managers need be ready to transact other rates by end 2021. To avoid surprises, the industry should take regulators at their word that, post 2021, they will constrain LIBOR issuance.
Besides, there are four other LIBOR currencies for which termination is expected in December 2021.
In 2021 we expect USD LIBOR issuance to increase and subdued pick-up of SOFR across cash and derivatives markets. Meaningful SOFR-linked liquidity will be pushed into 2022. Term SOFR will likely start becoming viable in 2022.
USD LIBOR’s publication extension suggests there is a first-mover disadvantage. However, this needs to be balanced against lagging too far behind and inviting regulatory scrutiny, let along facing unfavourable conditions in generating returns and exiting or turning positions over.
Asset managers should continue to focus on the business issues:
- What happens to my business if I cannot support new rates?
- Do my systems create constraints in what to invest?
- What happens to my funds where LIBOR sets performance fees?
- If I issue LIBOR loans or manage credit funds with LIBOR exposures, what happens if/when LIBOR dries up?
- Can I explain my project strategy to regulators and clients (and from 2021, possibly the media)?
It is important to note that the extension of key USD LIBOR settings opens up new issues:
- Basis risk between the end of issuance (expected by 31-Dec-2021) and the end of rate publication on 30-Jun-2023.
- Cross currency risk between a USD risk rate (USD LIBOR) and non-USD risk-free rates (eg: GBP SONIA)
Therefore, a transition project’s object must remain to:
- Be technically ready to transact in other rates, including the new risk-free rates.
- Establish exposures across holdings, agreements, counterparties, etc.
- Understand fallback terms in your contracts.
- Establish what can be mostly resolved via industry action vs not.
If you have a live project, do not defund it prematurely. If you do not have a project, the time to start is now. In USD we still need to be ready to transact away from LIBOR. In GBP, JPY, CHF and EUR LIBOR, nothing has changed.
In closing, we note that there is no cookie-cutter approach for the buyside. Every LIBOR transition project needs tailoring to each firm’s needs given:
- The project does not mean the same thing to every firm. It depends on what each asset manager trades.
- The transition involves multiple currencies & jurisdictions, asset classes, instrument types and product sets.
- Crucially, there is no defined end state. The goal is simply to transition away from LIBOR.