The transition from Interbank Offered Rates (IBOR) to Alternative Risk-Free Rates (RFRs) has an impact on all financial and non-financial institutions operating with the impacted floating reference rates. It affects a wide range of financial instruments on the derivative and cash markets.
This blog edition highlights notable developments made publicly available by the global regulatory community, industry working groups and/or infrastructure providers over the month of June 2021. You will find more detail in our monthly EY IBOR Transition Newsletter, to which you June subscribe through the following link.
Over this last month there has been a number of recent announcements by regulators and industry associations to market participants to increase progress in transition away from LIBOR.
The UK Financial Conduct Authority (FCA) published a consultation – for which the deadline is set on August 27, 2021 – on its proposed decision to require synthetic LIBOR for six GPB and JPY settings. Indeed, the FCA is consulting on using its new powers under the Benchmarks Regulation (BMR) to require the more widely used 1-month, 3-month and 6-month GBP and JPY LIBOR settings to be determined under a changed methodology (i.e. on a ‘synthetic’ basis) after end-2021:
- For GBP, the FCA has selected the term SONIA reference rate provided by ICE Benchmark Administration (IBA) as a component for the specific purpose of a potential synthetic GBP LIBOR.
- For JPY, the Tokyo Term Risk Free Rate (TORF) provided by QUICK Benchmarks has been selected as a component for a potential synthetic JPY LIBOR.
The consultation also set out the possible scenarios for use of synthetic LIBOR. Following this, the FCA anticipates that the primary need is in cash markets. However, the FCA has reiterated that any application of synthetic LIBOR will be limited and encouraged market participants not to rely on any potential synthetic LIBOR and to continue to actively transition away from LIBOR.
Moreover, the International Securities Lending Association (ISLA) recently published changes to LIBOR references in the GMSLA. This publication was in response to a consensus from members to produce a standard form amendment to assist market participants in their efforts to agree the deletion of references to LIBOR in their documentation.
Finally, the International Swaps and Derivatives Association (ISDA) launched a consultation on how to implement fallbacks for GBP LIBOR ICE Swap Rate and USD LIBOR ICE Swap Rate.
In order to address the potential cessation of these ICE swap rates, ISDA is seeking input on the implementation of:
- Fallbacks for the GBP LIBOR ICE Swap Rate suggested in a paper published by the Non-Linear Task Force of the Working Group on Sterling Risk-free Reference Rates (GBP RFR WG) in the UK; and
- Fallbacks for the USD LIBOR ICE Swap Rate proposed in a paper published by the Alternative Reference Rates Committee (ARRC) in the US.
The deadline for response is set on July 2, 2021.
- Observed trends in the GBP LIBOR market
We observe a high confidence in an orderly transition of the GBP LIBOR market.
Andrew Bailey, the Bank of England Governor, announced that he believes the sterling transition is proceeding very strongly and many of the issues have been resolved or addressed. Bailey said at the Association of Corporate Treasurers’ annual conference: “I think certainly for sterling we’re there, pretty much.” There is a number of contributing factors such as the fact that LIBOR’s replacement rate has been around since 1997, financial markets are relatively smaller and simpler, and the UK regulators have been much more prepared to instruct companies rather than pursue a purely market-lead solution.
June 17, 2021 was the date on which the FCA and BoE encouraged participants in the sterling exchange traded derivatives market to switch to SONIA. Beyond June, contracts expiring post 2021 should only be traded for risk management of existing positions. Those contracts expiring before the end of 2021 can continue as normal.
- Observed trends in the USD LIBOR market
The feeling is not same on the USD LIBOR side.
An ARRC report in March 2021 revealed that outstanding contracts referencing USD LIBOR are at $223tn, up from $200tn three years ago. Of which around 60% will mature before mid-2023 and $90tn will remain outstanding.
“While important progress is being made in some segments of the market, other segments, including business loans, are well behind where they should be”, according to Financial Stability Oversight Council (FSOC) lead who would like to see firms make the switch to SOFR in derivatives contracts this summer, referring to the “SOFR Fist” initiative.
The SOFR First initiative means a prioritization of interdealer linear derivatives trading in SOFR rather than LIBOR from July 26, 2021. One of the main drivers is to reduce interdealer hedging costs into SOFR and increase liquidity and visibility. Once the convention switch is in place, the ARRC expects that its market indicators for a SOFR term rate will have been met, allowing the ARRC to formally recommend the CME SOFR term rates very shortly thereafter. Indeed, the ARRC have suggested that a ‘SOFR First’ initiative, with a deadline of July, could pave the way for official endorsement of term-SOFR.
The SOFR First initiative is mirroring the ‘SONIA first’ initiative in Sterling swaps markets of October 2020. Within five months of the ‘SONIA First’ initiative, SONIA was the dominant benchmark for trades expiring post sterling LIBOR cessation. There is warning that as the sterling market is smaller than the dollar market and thus the initiative may not yield the same results. There is also a question around buy-side demand. However, confidence remains that a ‘SOFR First’ initiative will move things in the right direction if coordinated correctly. The ARRC chair Tom Wipf commented: “If we can arrive at a place where this ‘SOFR first’ initiative is as successful as it has been in the UK, we won’t be very far away from the endorsement of term SOFR”.
Further, increasing credit sensitive alternatives to SOFR is another reason behind the slow increase in SOFR liquidity. On June 1, 2021, IHS Markit launched another two new alternatives to SOFR: USD Credit Inclusive Term Rate (CRITR) and the USD Credit Inclusive Term Spread (CRITS). The rise of these alternative benchmarks is in part a response to market dissatisfaction with SOFR.
However, not the whole market feels the same way. Earlier this month, Gary Gensler, chair of the Securities and Exchange Commission (SEC) took aim at credit sensitive alternatives to SOFR, notably Bloomberg’s BSBY index, during the recent meeting of the FSOC. Gensler’s main concern is that the credit sensitive benchmark has much of the same flaws as LIBOR. Indeed, both benchmarks are based upon unsecured, term, bank-to-bank lending and BSBY has the same “inverted-pyramid problem as LIBOR”. Gensler suggests that BSBY “might look a bit different, but it’s still the same emperor” and importantly it still presents “similar risks to financial stability and market resiliency”.
Tom Wipif (ARRC chair) also commented that “LIBOR is going away very soon so transition efforts must accelerate” and that market participants should “choose wisely when moving off of LIBOR”. It is clear that while these rates may offer convenience as a short-term substitution, SOFR is based on a nearly trillion-dollar market and is a robust, proven reference rate that can anchor this transition.
For more information on these topics, please contact us directly.
You will find below the list of key developments in the IBOR transition over the month of June 2021, the detail of which can be found in our monthly EY IBOR Transition Newsletter.
- LMA published interview “LIBOR transition is here – Swiss borrowers at the ready”
- SIX announced that calculation for accrued interest for FRNs based on SARON has now been implemented
- EC published consultation outcome on the designation of a statutory replacement rate for CHF LIBOR
- Development of SARON
Eurozone specific highlights:
- EC, ECB, EBA and ESMA encouraged market participants to cease all LIBOR settings
- FSB published Global Transition Roadmap for LIBOR
- FSB published paper reviewing overnight RFRs and term rates
- FSB published statement on the use of the ISDA spread adjustments
- FSB published statement on smooth and timely transition away from LIBOR
- IOSCO published statement on smooth and timely transition away from LIBOR
- ISLA published changes to LIBOR references in GMSLA
- ISDA published its May ISDA-Clarus RFR Adoption Indicator
- ISDA launched consultation on fallbacks for GBP LIBOR ICE Swap Rate and USD LIBOR ICE Swap Rate
- ISDA published FAQs to Supplement 75 to 2006 ISDA Definitions
- ISDA published revised version of “Documenting RFR derivatives using different approaches to compounding/averaging under the 2006 ISDA Definition” memorandum
UK specific highlights:
- PRA published results and analysis for first DLT assessment of the SONIA OIS market
- LMA published updated reference rate selection agreement for use in legacy transactions
- LMA published exposure draft of standard terms and conditions for secondary debt training
- FCA and BoE encouraged market participants in switch to SOFR in USD interest rate swap markets
- LMA published updated list of loans’ referencing RFRs
- LMA published exposure draft trade confirmations
- FCA published consultation on proposed decision to require synthetic LIBOR for 6 GPB and JPY settings
US specific highlights:
- IHS Markit launched credit sensitive SOFR alternatives
- CTFC’s Interest Rate Benchmark Reform Subcommittee recommends transitioning interdealer swap market trading conventions from LIBOR to SOFR
- ARRC welcomed CTFC’s Subcommittee’s recommended dates for transitioning interdealer swap market trading conventions to SOFR
- ARRC held third event in SOFR Symposium series
- SEC’s Chair published LIBOR statement
- ARRC welcomed and highlighted messages from recent FSOC principals meeting