The first in a series of LIBOR transition breakfast events took place in London on the 27th November 2018. We were oversubscribed for our 24 person event where we heard about the progress that members of ISDA and London Money Market Association (LMMA) have made against their plans. There was also great insight into how the US regulator and banks are planning their transition to a risk free rate.
Key Highlights and Themes from the Discussion
General insights including a perspective from the US
- 95+% of new debt and derivatives transactions are still being booked against Libor benchmark – the first consultation on Libor transition took place in 2013 and, 5 years later, the financial services industry is still working towards this!
- Only now does it feel like institutions are thinking about customer impact – a customer view of data is required especially across structured products, hedging products for Loans, FRN and pref share issuance – what happens if Customers are disadvantaged with the move to a different benchmark?
- General feeling and consensus that industry bodies are working in silos when they could benefit from working together.
- There was agreement that even when there are conclusions on the alternative and replacement global reference rates, that a staggered migration will be required with a key challenge around execution.
- Regulatory bodies, including the Bank of England may not have a mandate to enforce a replacement rate, they have just defined that Libor is not fit for purpose and that banks need to provide a solution and implement it.
- When new rates are agreed and sourced, curve and model construction will need re-validation which will put a lot of pressure on the regulator/banks and will not conclude before Libor is replaced, therefore higher Capital requirements are likely.
- Huge documentation change required in OTC (probably triggered via ISDA protocols) and across all other product areas, including individual Loan customers.
- US Banking and Financial Services industry is very different to London market, with 6,000+ banks and a massive mortgage industry.
- A possibility of some form of equivalent version or prompt to the FCA’s “Dear CEO Letter” is expected in 2019 in the US.
- Concern raised that at some point, someone will challenge the veracity of the Libor benchmark, based on lack of underlying representative transactions as they are impacted by rising rates, and the potential systematic impact of a successful challenge.
Dear CEO Letter
- This letter challenged the market’s expectation that the industry will do the transition to risk free benchmark rates ‘for them’.
- Dear CEO letter has created an urgency and focus around the initial planning, although this has been difficult when it is not clear what the market is migrating to.
- There is a wide spread in the likely responses from the Banks, and this will lead to the Bank of England feeding back to individual firms on their planning, probably based on best-in-class responses.
- Key issue in responding to the letter has been the ability for institutions to be able to get a meaningful cut of data in order to reflect exposure in the 10-week timeframe given.
- Non-UK banks need to nominate a senior manager for their global programme causing potential governance problems.
LMMA
- Key mandate for LMMA is to ensure that, from a market perspective, the relevant authorities including the Bank of England are not making decisions that won’t work in practice.
- LMMA Members (~35 members) are waiting for the regulator to define the replacement for Libor (including term fixings) with a population analysis being completed at present.
- Limited progress in dealing with legacy contracts.
- Limited progress in establishing forward or true term rates.
ISDA
- ISDA’s immediate focus is emergency documentation measures for fall back provisions, protocol likely to be adopted.
- The transition to a risk free rate will be easier for derivatives and more difficult for loans and retail products – if SONIA replaces Libor even with no term fixing, derivative users may be less impacted than cash product users, as overnight interest swaps are already being done in this manner.
- ISDA’s focus is to make sure the contracts are robust, amendment language is clear – not to fix the underlying market issues.
- ISDA’s website will be updated shortly to advise on indicative timelines for work being completed in the Libor space including an operational check list outlining considerations for implementation.
- An ISDA consultation paper for USD on approaches to term rates and issues with fall back provisions will be issued early in 2019.