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Special Report 2019 Risk.Net Libor in depth Special report 2019 Risk.net Sponsored by LID_OFC_0919.indd 89 15/08/2019 16:43 Opinion Libor – How seven firms are tackling the transition Lukas Becker Desk Editor, Derivatives [email protected] t the law firm Fieldfisher’s offices near London Bridge in June, around 75 people gathered in a meeting Joanna Edwards Senior Director, Marketing Solutions A room for a seminar on Libor transition. [email protected] During the event, the audience of buy- and sell-side executives answered poll questions on their Stuart Willes smartphones. The answers were not encouraging. Commercial Editorial Manager Asked: ‘How prepared are you for Libor discontinuance?’, two-thirds said they were just “starting to think [email protected] about it”. None had begun moving Libor positions to new risk-free rates (RFRs). Alex Hurrell, Commercial Subeditor Only one-quarter expected to transition all of their exposures away from Libor by the end of 2021, and [email protected] nearly half predicted they would only be able to get 50–80% of the work done in time. Antony Chambers, Publisher, Risk.net This was a small sample size, and the results should be taken with a pinch of salt. But polls at other industry [email protected] gatherings also give the impression that, despite clear warnings, Libor may disappear soon after 2021 – at Robert Alexander, Sales Manager which point the UK Financial Conduct Authority (FCA) will no longer compel banks to submit quotes to the [email protected] various benchmark panels – market participants have done little about it, at least so far. There are exceptions. Risk.net spoke with a number of forward-thinking firms in a range of sectors – David Pagliaro, Group Managing Director [email protected] corporates, asset managers, insurers, regional banks, clearing houses and supranational issuers – about the progress they have made in transitioning away from Libor, and the findings have been aggregated into a series Ben Wood, Group Publishing Director [email protected] of seven profiles published in this report. UK-based firms appear to have made the most headway, and the series kicks off with LCH, which has a key Ben Cornish, Senior Production Executive [email protected] role, especially with secured overnight financing rate (SOFR) swaps. The clearing house found a way to safely accept the contracts for clearing without waiting for bilateral liquidity to build, as it does with most products. Infopro Digital (UK) Next year will see the discounting rate for US dollar Libor swaps changed to SOFR, a move that is expected to Haymarket House, 28–29 Haymarket London SW1Y 4RX boost demand for SOFR swaps. Tel: +44 (0)20 7316 9000 BMO Global Asset Management is a liability-driven investment manager based in London, which, as of Infopro Digital (US) June, has moved nearly 95% of its £10 billion ($13 billion) sterling Libor swaps portfolio onto the sterling 55 Broad Street, 22nd Floor overnight interbank average rate (Sonia). The firm targets pockets of liquidity from asset swaps and unwinds, New York, NY 10004-2501 Tel: +1 646 736 1888 and all of its new sterling swap trades are linked to Sonia. Associated British Ports is proof that corporates don’t need to be laggards in the transition. The company Infopro Digital (Asia-Pacific) moved more than £500 million of sterling Libor swaps onto Sonia late last year, and on June 11 met holders of Unit 1704-05, Berkshire House Taikoo Place, 25 Westlands Road its listed floating rate notes to convince them to switch the benchmark to the sterling overnight rate. Hong Kong, SAR China The European Investment Bank issued a Sonia-linked floating rate note last year – an oversubscribed Tel: +852 3411 4888 £1 billion bond – and, in the process, worked out the kinks of using the compounded-in-arrears methodology Cover illustration to calculate coupon payments. It is now trying to take the formula to the US, and beyond. Richard Osley/NB Illustration Toronto Dominion Securities was bookrunner on the EIB’s first Sonia issue, as well as on some early US SOFR deals. It helped create the standard structure in the UK, where coupons are calculated by compounding Published by Infopro Digital © Infopro Digital Risk (IP) Limited, 2019 the overnight rate in arrears, but has found that a lack of consistency in SOFR deals has held back progress in the US. For other markets, progress has been a little slower. US insurer Prudential Financial is still testing the pipes with some SOFR swap trades, and getting accustomed to some of the technical differences inherent in the new products. Hartford, Connecticut-based Webster Bank, meanwhile, is preparing to repaper legacy loan and swap contracts, and implementing the client education process that goes along with that effort. Included in the series is an interview with Cornelia Holthausen, deputy director-general in the directorate All rights reserved. No part of this publication may be reproduced, stored in or introduced into any retrieval system, general market operations division of the European Central Bank, who speaks to Risk.net about transitioning or transmitted, in any form or by any means, electronic, from Eonia to the euro short-term rate, and how long Euribor can really hang around. mechanical, photocopying, recording or otherwise, without the prior written permission of the copyright owners. Risk is Lukas Becker registered as a trade mark at the US Patent Office Derivatives editor, Risk.net risk.net 1 LID_Intro_0919.indd 1 05/09/2019 12:53 Contents 4 LCH LCH brings SOFR swaps into the fold Central counterparty adapted its risk models to begin clearing the new swaps 6 BMO Global Asset and plans a quick switchover to SOFR Management discounting next year BMO – Setting the pace in Libor transition As an early mover, BMO switches £10 billion of pension liability swap hedges to Sonia 8 Prudential Financial 9 European Investment Bank 12 Webster Bank Taking SOFR for a test drive EIB sees prizes and pitfalls Webster Bank – Small lender in Libor reform eyes big SOFR challenges Test trades have allowed US insurer Prudential Financial to start getting The Sonia bond trailblazer wants a single The Connecticut-based firm is focusing used to a life without Libor bond template for all risk-free rates, but on client education and fallbacks found hidden devils in its debut 14 TD Securities 16 Associated British Ports 19 European Central Bank TD Securities – The Sonia ABP crafts blueprint for ECB’s Holthausen on Euribor, FRN standards bearer corporate Libor switch fallbacks and Eonia’s end Canadian bank TD Securities shows the US UK port operator embraces Sonia for The QE wind-down could boost Euribor, market can handle compounded coupons swaps, bonds and loans but panel bank expansion is unlikely 2 Libor in depth Special report 2019 LID_Contents_0919.indd 2 04/09/2019 14:10 LCH LCH brings SOFR swaps into the fold Central counterparty adapted its risk models to begin clearing the new swaps and plans a quick switchover to SOFR discounting next year. By Helen Bartholomew s custodians of mutualised risk – A$375 trillion notional of it – clearing houses have strict guidelines governing how and when new products are brought into the fold. Derivatives typically need a track record of liquidity in bilateral markets and observable pricing on trading venues before they are even considered for clearing. Benchmark reform, however, has turned this premise on its head. In July 2018, just three months after the Federal Reserve began publishing the secured overnight financing rate (SOFR), LCH SwapClear cleared its first swaps linked to US dollar Libor’s risk-free successor rate. “It’s fair to say that the clearing rules and the framework set up to get products into clearing didn’t quite anticipate benchmark reform,” says Philip Whitehurst, head of service development for rates derivatives at LCH. “We managed to ensure that we were covering all of the risks attendant with clearing swaps linked to new risk-free rates [RFRs].” Given Libor may end after 2021, allowing Once the rate was selected by the industry-led US their tainted submissions-based predecessors. liquidity to build in bilateral markets before bringing Alternative Reference Rates Committee (ARRC) in “If a clearing house is holding enough margin SOFR swaps into the cleared world was not an June 2017 and the methodology was known, LCH to cope with a ‘less robust’ rate, then that should option. At the same time, new rules incentivising switched into development mode, using a backfilled give a greater level of certainty about the ability to clearing – via mandate and higher capital and time series to make the necessary assumptions effectively risk manage products linked to a similar, margin costs on bilateral trades –mean it’s cheaper around topics such as liquidity and likely behaviour. but more robust rate,” Horner says. to use capital-light cleared Libor swaps than the It’s easy to think that heavy reliance on assumptions new, regulator-endorsed RFR. So the clearing house rather than hard trading data translates into lower Discounting update had to bite the bullet and start clearing SOFR risk standards, but that’s not necessarily the case, as With speed-to-market a crucial factor, LCH opted to swaps anyway. LCH’s Whitehurst stresses. make some compromises at launch, accepting that “Launching a new contract directly into clearing “We’ve still got the same risk management in-flight updates would be required once the service is more challenging from a risk management standards, but we’ve had to go about things in a was up and running.
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