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 July 2021. You will find more detail in our monthly EY IBOR Transition Newsletter, to which you can subscribe through the following link.
As we start to approach the “LIBOR end game” we witness more statements by key regulators and working groups in order to help improve the pace of transition.
July 2021 marked an important milestone on the FINMA LIBOR transition roadmap as new contracts should now in general be based on alternative reference rates (ARRs). According to FINMA’s self-assessment survey, a large fraction of the cash markets already transitioned to SARON, but some market participants still need to accelerate their reduction of legacy LIBOR contracts. We have also seen important communications from the Swiss Franc National Working Group (CHF NWG) in its efforts to foster the transition progress. For cash markets, CHF NWG recognized further compounding in advance options where the rate needs to be known at the beginning of the interest period. For derivative markets, the CHF NWG recommended start dates for using only SARON swap curve as single price reference from September 1, 2021 and as benchmark in derivative markets from July 1, 2021 (SARON First) (except for LIBOR hedging).
Given EONIA will also terminate in less than 6 months, contingency plans will likely be required to trigger contracts and transactions referencing EONIA without successful renegotiation. Many market participants have faced long bi-lateral renegotiations which have been further hindered by the pandemic and Brexit. As a consequence, “many clients [are] unable to prioritise requests, unable to commit to transitioning before the end of the year, or simply unresponsive” according to the Letter from the Chairman of the EUR Risk-Free Rates Working Group (EUR RFR WG) to the European Commission. The EUR RFR WG survey revealed that of its members who participated, they estimate that they are 46% of the way through their transition away from EONIA. Therefore, the EUR RFR WG have proposed the designation of a statutory replacement rate for EONIA as part of a comprehensive solution for cash and derivative products. Although it should be noted that, the new European Commission’s powers (Article 23A of the Benchmark Regulation) will not cover all contracts so this is not a panacea. The EUR RFR WG further stress that the primary objective of market participants should remain to actively transition to €STR flat and that any decision made by the European Commission to designate a statutory replacement should not impede progress of market participants actively transitioning to €STR flat.
Uncertainty over USD LIBOR’s successor has slowed issuance of popular rates structured products, such as range accruals. SOFR has also struggled to gain traction in dollar-denominated caps and floors. Lenders worry that loans linked to the rate could become unprofitable in stress scenarios, when bank funding costs tend to diverge from RFRs.
However, the Alternative Reference Rate Committee’s (ARRC) formal recommendation of CME Group’s SOFR Term Rates on July 29, 2021, marks a major milestone in the transition away from USD LIBOR. The successful SOFR First convention change, along with continued growth in SOFR cash and derivatives markets, has allowed the ARRC to recommend SOFR Term Rates.
Therefore, market participants now have every tool they need to transition and are encouraged to accelerate progress to end use of LIBOR. Further, with regulators becoming increasingly vocal about the use of so-called credit sensitive rates, market participants should closely examine what rates they will use over the next few months to ensure they are adequately prepared.
You will find below the list of key developments in the IBOR transition over the month of July 2021, the detail of which can be found in our monthly EY IBOR Transition Newsletter.
- CHF NWG published summary of its July 1, 2021 meeting
- FINMA published guidance on derivative trading obligations under the FMIA
- LCH SwapAgent processed its first SARON / SOFR cross-currency swap basis
- Development of SARON
Eurozone specific highlights:
- ESMA published consultation on clearing and derivative trading obligations in view of the benchmark transition away from EONIA and LIBOR
- EUR RFR WG called for expression of interest in joining the working group
- Chairman of EUR RFR WG published letter to the EC to support statutory replacement of EONIA
- EC announced intention to adopt a draft Implementing Act by Q3 2021 to designate statutory replacements for EONIA
- EUR RFR WG published minutes from its July 1, 2021, meeting
- IAIS published statement on benchmark transition
- ISDA published supplement 77 to the 2006 ISDA definitions to update self-compounding rate options for the RFRs
- FSB published progress report to the G20 on LIBOR transition issues
- FSB published statement urging action to complete the transition away from LIBOR by end-2021
- ISDA published its June 2021 ISDA-Clarus RFR Adoption Indicator
- ISDA published commentary: “The LIBOR End Game”
- ISDA launched its “Understanding IBOR Benchmark Fallbacks” microsite
- ISDA announced results of its consultation on fallbacks for the GBP and USD ICE Swap Rates
UK specific highlights:
- BoE official urged companies to identify “absolutely pervasive” LIBOR exposures outside financial sector
- UK Finance urged businesses to check on LIBOR exposure before the rate change at the end of 2021
- GBP RFR WG published June 2021 edition of its newsletter
- GBP RFR WG published paper: “Active transition of legacy GBP LIBOR loan contracts – timelines and considerations for borrowers”
- FCA published consultation on changes to derivative trading obligation due to LIBOR transition
- FCA published 2021/22 Business Plan in which it highlighted LIBOR transition as a priority
- LMA published further RFR documentation to assist the market with LIBOR transition
- FCA and BoE encouraged market participants in a switch to RFRs in the LIBOR cross-currency swaps market from September 21, 2021
US specific highlights:
- ARRC welcomed FHFA supervisory letter on transition away from LIBOR
- Tradeweb announced first fully electronic SOFR Swap Spread Trade
- MRAC adopted SOFR First recommendation at public meeting
- ARRC commended the MRAC’s formal adoption of a recommendation of a SOFR First convention switch
- ARRC announced fourth event in its series: “The SOFR Symposium: The Final Year”
- ARRC endorsed MRAC recommendations for September 21, 2021 “RFR First” move of interdealer cross-currency swap market trading conventions
- ARRC published scope of use for Term SOFR
- ARRC published forward looking Term SOFR and SOFR Averages conventions for syndicated and bilateral business loans