Deloitte LIBOR Transition Newsletter Deloitte LIBOR Transition Newsletter January 2021 Regulatory Updates: 12.01.20 – 12.31.20 Market Updates: 12.01.20 – 1.14.21
Deloittei US LIBOR Transition Newsletter A summary of US regulatory and market updates related to the transition from LIBOR
Executive Summary Regulatory Updates Global Highlights Our Perspective Market Updates
Executive Summary
The Alternative Reference Rates Committee (ARRC) held a virtual meeting in early December 2020 to address recent developments relevant to the LIBOR transition. The meeting included discussions related to the recent announcements from the Intercontinental Exchange (ICE) Benchmark Administration (IBA), the United Kingdom’s (UK) Financial Conduct Authority (FCA) and related supervisory guidance from US regulatory authorities in December 2020. Following these announcements, IBA launched a consultation on its plans to cease publishing LIBOR rates. Pending final confirmation of this consultation, these announcements jointly provide a clearer path for USD LIBOR cessation: a call for banks to stop issuing new USD LIBOR contracts as soon as possible, and no later than end of 2021, as well as a concrete cessation date subject to the IBA consultation outcome. The ARRC also led a group discussion with current ARRC Members covering their issued best practices. There was a consensus that the best practices timelines and guidance were in line with the wider effort from the IBA, FCA, and US regulators.
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Deloitte LIBOR Transition Newsletter
Bank of England (BoE) Executive Director Andrew Hauser published a speech titled “Bowing Out Gracefully: LIBOR’s Retirement Draws Near”, concisely describing specific steps businesses and lenders may want to take to minimize disruption in advance of LIBOR’s permanent cessation. Hauser listed three clear actions: (1) “Moving all new business off LIBOR”, (2) “Adopting the International Swaps and Derivatives Association (ISDA) fallbacks for existing derivatives”, and (3) “Reducing the legacy of post-2021 LIBOR-linked contracts”. The first step of moving new business off LIBOR inherently reduces the population of contracts at risk of uncertainty related to LIBOR’s cessation. This alone can place market participants at an advantage and may reduce the lift required when transitioning. Hauser discussed the ISDA protocol as it relates to adopting the ISDA fallbacks for existing derivative contracts to protect legacy LIBOR-linked derivative trades, which account for the majority of LIBOR-linked business (valued at hundreds of trillions of dollars). Finally, Hauser addressed other non-derivative legacy LIBOR contracts, which equally plan to be transitioned and are under regulatory watch.
The European Commission issued a statement welcoming an agreement reached by the European Parliament and the Council on important amendments to the European Union (EU) Benchmark Regulation, proposed in July 2020, intended to promote stability in financial markets in response to the phase-out of widely used benchmarks. The agreed amendments grant the European Commission the power to designate a replacement benchmark when necessary to avoid disruption to EU markets. This represents an important step in the attempt to seamlessly transition millions of LIBOR-linked products ahead of its planned cessation after 2021. The agreed amendment plans to take into effect immediately upon its publication in the Official Journal of the European Union.
In December 2020, the LCH confirmed that they will adopt ISDA Fallback and ]requested feedback on a consultation to build and run a conversion process for any LIBOR swaps remaining at (or shortly before) an index cessation effective date that were cleared using their SwapClear service. The proposed conversion process intends to convert the remaining LIBOR trades to market standard RFR trades accompanied by a cash compensation for any differences between the ISDA Fallback convention and the market standard convention, a difference primarily due to the spread adjustment component built into the ISDA Fallback. Additionally, the consultation sought feedback on the legal component for the conversion process. The LCH consultation was followed by a similar proposal from the CME group on January 14, 2021, asking participants whether they would be supportive of a CCP led conversion process for cleared OTC interest rate swaps. CME cites that this approach would benefit market participants by providing certainty that their “legacy” and “new” contracts would be fungible with one another while reducing the operational complexity of implementing IBOR fallbacks.
Key Upcoming Dates • January 25, 2021 – ISDA’s expected effective date of the IBOR Fallbacks Supplement and the IBOR Fallbacks Protocol.
Our Perspective
The ARRC’s December Virtual Meeting The ARRC’s December virtual meeting with ARRC members marks a growing consensus among market participants and US regulators that milestones and goals are aligned and well targeted to achieve the intended plan for a smooth transition away from LIBOR. Although the final outcomes of the IBA’s consultation are still to be confirmed to determine the official cessation date for certain LIBOR tenors, lenders now have a clear path to follow in terms of critical steps to take and key dates to expect in advance of LIBOR’s permanent cessation.
Andrew Hauser’s “Bowing Out Gracefully: LIBOR’s Retirement Draws Near” Andrew Hauser’s published speech provides a framework for other market participants to facilitate their own LIBOR transitions while also considering regulators’ watchful eye even when it comes to legacy LIBOR products, which may not be covered by the overarching ISDA protocol. This reminder serves as an important message to market participants, through the following the key recommendations: move all new business off LIBOR as soon as possible, sign the ISDA protocol and convert remaining legacy contracts away from LIBOR.
EU Benchmark Regulation Amendments The agreement between the European Parliament and the Council regarding the Benchmark Regulation amendments marks an important milestone in the transition away from LIBOR. Effective upon publication, The European Commission plans to have the power to select an official replacement rate for reference rates that are phasing out, particularly relevant to LIBOR’s imminent cessation. This effort is specifically targeted at maintaining financial stability in the markets amidst potential uncertainty, a major concern of regulators across the globe when it comes to the LIBOR transition.
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Deloitte LIBOR Transition Newsletter
LCH and CME Consultations The LCH and CME consultations published this month show a clear intent on the part of regulators to provide clarity and certainty to market participants who hold LIBOR-linked swaps which may be impacted by the LIBOR cessation. Although the LCH and CME commend ISDA for the work they have done to date with respect to updating contractual fallbacks away from LIBOR, they note that resorting to fallbacks alone may not be enough to achieve a smooth and orderly transition. The ISDA IBOR Fallbacks are a good safety measure for a broad range of derivative agreements as they address the LIBOR transition risks, however, within the cleared swaps environment, central clearinghouse counterparties (CCPs) may still have mandated risk management responsibilities, namely ensuring contracts remain liquid and can be unwound in the event of default. Both consultations therefore propose a conversion of legacy LIBOR swaps to market- standard OIS contracts shortly prior to contracts moving to ISDA Fallback upon actual LIBOR discontinuation. The differences in ISDA Fallback convention, which is based on a compounded in arrears rate with observation shift and 2-day lookback and the market-standard RFR (e.g., secured overnight financing rate (SOFR) overnight indexed swap (OIS) rate) which is based on a compounded in arrears rate with no observation shift and 2-day payment delay, may result in payment dates shifting by 1-2 business days. Among other impacts from this second transition, clients would need to assess whether the back-to-back uncleared swaps and the loans they hedge may need to be transitioned to the same convention as the cleared derivatives. This conversion may facilitate a transition to a more liquid market-standard derivative product liquidity and reduce the need for the review, tracking, and repapering of these contracts without which firms would be exposed to significant conduct risk. Market participants are asked to share feedback by the end of the month.
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Deloitte LIBOR Transition Newsletter
Regulatory Updates
Summary of ARRC Office Hours Q&A with David Bowman Federal Reserve Board (FRB) This section represents a summary of the ARRC office hours Q&A with David Bowman from December 1, 2020 until December 31, 2020. Weekly office hour information can be found here. The information below does not represent the view of the FRB but represents the personal views of David Bowman outside of his official capacity. Below are some of the specific topics discussed:
One-Week and Two-Month LIBOR Cessation Date • Both one week and two-month LIBOR are not widely used tenors and are easier to end early compared to other tenors. As such, these are expected to cease to exist after December 2021. It is unlikely that other tenors will end earlier than anticipated.
Observation Shift Calculations • Typically, when calculating interest payments in arrears, payments depend on a compound or simple average of SOFR over an interest period which is determined at the end of that interest period. Different conventions exist to allow for more time to determine the payment amount and ensure it can be sent and received on time. The most common convention is a lookback – to calculate interest today, a look back would be applied for a certain number of business days to the calculation. There are two variants to a lookback calculation – a simple lookback and a lookback with an observation shift (the lookback not only determines the rate but the weight to be applied to the specific rate). The lookback structure always looks back to a business day and applied on business days.
SOFR FRB Conventions • The rate calculated for repo transactions based on the SOFR FRB conventions printed today refer to the rate published on the previous day. However, the terminology for SOFR averages is different in that the rate published on a given day is used that day. For the SOFR overnight rate, one would look back for the value date in the way the conventions are set out (how many contracts are written). There is an automatic one day look back in this method.
The ARRC and LIBOR Extension Announcements • Recent announcements regarding the extension of certain LIBOR tenors do not affect the ARRC’s goals or the work to review proposals. The announcements, however, do potentially add some time to help these efforts.
IBA Consultation on LIBOR Extension • If the IBA were to announce that LIBOR plans to cease to exist at the later date of June 30, 2023, it is not likely that the FCA would make a public unrepresentativeness statement. The extension of LIBOR would only be possible with the voluntarily agreement from enough banks to submit quotes until that date in a representational manner.
Other LIBOR Currencies Extensions • There are no plans to extend any other LIBOR currencies beyond December 2021 other than USD LIBOR.
FRB Announcement • The FRB issued guidance on November 30, 2020 urging banks to stop new issuances referencing USD LIBOR after 2021, but also encouraged banks to stop issuing LIBOR-linked instruments as soon as possible since there are no limitations on the purchase and sale of legacy LIBOR instruments. There is no intent to create any decline on liquidity or create any prohibitions on the trading of legacy LIBOR agreements.
ARRC Updates to Legislative Solution • The ARRC released an updated version of the proposed legislative solution for tough legacy agreements. The updates contained therein were intended only to clarify language, not to change the intent or intended outcomes of the legislation. The changes covered topics such as conforming changes, referencing SOFR as the fallback, and rights of determining person.
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Deloitte LIBOR Transition Newsletter
Regulatory Highlights • The ARRC held a virtual meeting in early December to address recent developments relevant to the LIBOR transition. The meeting minutes are available here. • BoE Executive Director published a speech describing specific steps businesses and lenders need to take to minimize disruption in advance of LIBOR’s permanent cessation. The speech is available here. • The European Commission issued a statement welcoming the agreement reached by the European Parliament and the Council on important amendments to EU rules on financial benchmarks. The article is available here.
ARRC Working Group • The FRB welcomed and supported the release of the proposal and supervisory statements that would enable a clear end date for USD LIBOR. The press release is available here. • The FRB, Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC) issued a statement encouraging banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable. The joint press release is available here. • The ARRC issued a press release supporting the statements by numerous US Regulatory Agencies and on the IBA LIBOR cessation consultation. The press release is available here. • The ARRC released conventions for using SOFR in Arrears in Bilateral Business Loans. The press release is available here. • The ARRC released a guide and a link to the new ISDA Webinar on USD LIBOR Endgame Developments. The guide and webinar are available here. • The ARRC released their October - November 2020 Newsletter. The bi-monthly newsletter available here. • Credit Sensitivity Group (CSG) conducted a webinar on the transition from LIBOR. The webinar is available here and the event materials are available here. • The ARRC published updates to their Frequently Asked Questions (FAQ’s). The updated FAQ’s are available here.
ISDA Updates • ISDA issued a statement on IBA and UK FCA announcements on LIBOR consultations. The press release and statement are available here. • ISDA published the supplements and updates to the 2006 ISDA Definitions. The supplements are available here. • ISDA published a video interview: “Why Should I Update the Fallbacks in My Derivatives Contracts?”. The video is available here. • ISDA conducted a webinar: “The Path Forward for LIBOR”. The webinar is available here. • ISDA’s virtual event on January 14, 2021: “Understanding the New IBOR Fallbacks” has open registration. The registration and information are available here. • ISDA published its ISDA-Clarus RFR Adoption Indicator for November 2020. The notes are available here.
Other News/ Useful Reading • “US banks cede to SOFR lending as credit hopes fade”. The article is available here. • “Federal Reserve says key bank lending rate will be phased out by June 2023”. The article is available here. • “LIBOR’s Final Retirement Date May Get Delayed Until Mid-2023”. The article is available here. • “Firms may be shut out of swaps on LIBOR issue, CFTC chief warns”. The article is available here. • “LIBOR’s Likely Reprieve Is a Welcome Acknowledgment of Reality”. The article is available here. • “Dollar LIBOR reprieve sparks fallback uncertainty”. The article is available here. • “Market mulls USD LIBOR transition delay”. The article is available here. • “New US Dollar LIBOR deadline doesn't guarantee a smooth transition”. The article is available here. • “End of LIBOR jolts multitrillion-dollar derivative market again”. The article is available here. • “LIBOR needs a legislative fix even if demise has been delayed”. The article is available here. • “Fed and FCA see path to synthetic dollar LIBOR”. The article is available here. • “Fallback dodgers walking a difficult path ”. The article is available here. • “SOFR credit debate is “hindrance” to corporate transition”. The article is available here. • “Cross-currency swaps will use RFRs on both legs”. The article is available here. • “LIBOR replacement race picks up with Ameribor swap debut”. The article is available here. • “Why ditching LIBOR is vexing the financial world”. The article is available here. • “SOFR Emerging As Alternative To LIBOR In U.S. Debt Markets”. The article is available here.
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Deloitte LIBOR Transition Newsletter
Market Updates
Decrease in Debt Issuance Referenced to SOFR The issuance size of SOFR referenced debt decreased in December 2020 compared to the issuances in November 2020. The issuance was $38.54 billion in December 2020 which decreased from $47.34 billion in November 2020. The graphs below represent data through December 31, 2020.
The cumulative issue size of SOFR bonds outstanding (this excludes matured bonds) is currently $682.07 billion with 877 bonds through January 14, 2021. There were 77 new issuances in December 2020, November 2020 and October 2020.
In December 2020, federal agencies issued 40 SOFR referenced Floating Rate Notes (FRNs) worth $27.35 billion. There were 37 other institutions which contributed $11.18 billion to the outstanding amount of SOFR referenced debt.
Decrease in Longer Dated Debt Issuance (maturity >=10 years) Referenced to SOFR SOFR debt issuances with a maturity greater than or equal to five years decreased in December 2020 compared to November 2020. During December 2020, there were 7 bonds issued which have a maturity between five and ten years. The issuances during December 2020 includes 23 bonds with an amount outstanding of $608.75 million which have a maturity greater than or equal to ten years, which has decreased significantly as compared to $6.38 billion in November 2020.
There were 302 issuances of SOFR bonds outstanding worth $167.89 billion, with a maturity greater than or equal to five years, through January 14, 2021 including 240 issuances worth $93.49 billion with a term greater than or equal to 10 years.
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Deloitte LIBOR Transition Newsletter
Cumulative SOFR Interest Rate Derivatives SOFR Swaps SOFR Futures • The cumulative traded notional for SOFR based • As per the data available on Chicago Mercantile interest rate and basis swaps totaled $1,682.2 Exchange (CME), for December 2020, SOFR billion through December 25, 2020. futures average daily volume reached 66K • For the month of December 2020, the notional contracts/ day. The data is available here. volume of SOFR-based interest rate and basis • The month-end open interest for SOFR futures as swaps totaled $182.3 billion compared to the of December 2020 was around ~681K contracts. $190.4 billion in November 2020, and $231.2 The data is available here. billion in October 2020.
Global IBOR Activity The market activity in Sterling Overnight Index Average (SONIA), Swiss Average Rate Overnight (SARON) and Euro Short- Term Rate (€STR) based debt issuances and swaps have continued to increase. The table below represents the cumulative bond issuances (does not exclude matured bonds) and the cumulative notional of swaps outstanding through December 31, 2020.
Swaps Bonds Alternative Cumulative notional amount Cumulative issuance amount Reference Rate (US $ Billions) (US $ Billions) SONIA 32,281.1 95.3 SARON 59.6 NA TONA 590.5 NA €STR 79.6 4.2 Source: Bloomberg, http://swapsinfo.org/, compiled by Deloitte Data as of December 31, 2020
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Deloitte LIBOR Transition Newsletter
Global Highlights
United Kingdom • “FCA response to IBA’s proposed consultation on intention to cease USD LIBOR”. The statement is available here. • Sterling Risk-Free Rate (RFR) Working Group updated its LinkedIn page on the transition away from LIBOR. The website is available here. • Options and mid-curve options based on three-month SONIA index futures went live at exchange group ICE through its ICE Futures Europe business. The article is available here. • “Trig takes the loan leap to Sonia”. The article is available here. • “BoE tells markets to control destiny beyond LIBOR”. The article is available here.
European Union • “€STR transition stymied by addiction to EONIA”. The article is available here. • “Fears EU’s ‘tough legacy’ fix could tie risk managers’ hands”. The article is available here. • “In Search of a Common Market Standard for EURIBOR Fallback Clauses”. The article is available here. • “Loan market wrestles with the last days of LIBOR”. The article is available here.
Asia • The Association of Banks in Singapore (ABS) published the responses to feedback received on the report “SIBOR Reform and Future Landscape for Singapore Dollar (SGD) Interest Rate Benchmarks”. The report is available here. • The ABS published the timelines for the discontinuation of SIBOR by end-2024. The report is available here. • The ABS published the SORA guide for corporates and SMEs. The guide is available here. • The ABS released the December series of seminars and workshops to share insights with industry players on the transition from SOR to SORA. The webinars and materials are available here. • “The Oversea-Chinese Banking Corporation (OCBC) extended more than $1b in Sora-linked home loans since launch”. The article is available here. • “Hong Kong Exchanges and Clearing (HKEX) completes first client cleared trade for Japanese banks”. The article is available here. • “CME’s TriOptima completes first Japanese Yen compression”. The article is available here. • “Japan weighs benchmark options as sun sets on LIBOR”. The article is available here.
Australia • Australian Securities and Investments Commission (ASIC) published an information sheet: “Managing conduct risk during LIBOR transition”. The information sheet is available here.
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Deloitte LIBOR Transition Newsletter
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