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Libor's Long Goodbye

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LIBOR’S LONG GOODBYE Readiness for LIBOR transition TRANSACTIONAL POWERHOUSE 1 CASE0155238_Report_Print Ready.indd 1 21/07/2020 12:06:23 Introduction As has been noted in a continuous drumbeat of warnings from major global, regional and local regulatory bodies, LIBOR is expected to go away at the end of 2021, when the UK Financial Conduct Authority (FCA) has announced it will withdraw support for the rate. This deadline was first announced This report also includes a matrix written, in each case that mature in a speech by Andrew Bailey, chief showing an assessment of readiness after 2021. The official sector executive of the FCA, in July 2017. for transition by currency and product of regulators and central banks Since more than half of the roughly type. As we’ve noted previously, continues to stress the need to four-and-a-half-year-period that that LIBOR transition is at different develop robust alternative reference speech gave until the deadline has stages of progress in different rates and robust contractual fallbacks now elapsed, it is perhaps fitting to jurisdictions and with respect to in the event that LIBOR were to consider how far markets have come different financial products. cease or become unrepresentative in LIBOR transition, and how much of underlying financial reality, and to further they need to go. LIBOR transition remains a transition to such alternative rates. fundamental issue confronting Despite the uncertainty that exists, the This report assesses the state of financial markets. To date, transition FCA has stated firmly that the end-2021 readiness for transition from LIBOR has been slower than regulators deadline remains in effect, a statement (and other interbank offered rates would like, and considerable it reiterated on 25 March 2020 in (IBORs)) to alternative interest rates uncertainty still exists (and may response to the Covid-19 pandemic. in the jurisdictions of each LIBOR well remain for some time). Time currency (and select other jurisdictions) is growing shorter until the end of with respect to derivatives, loans, 2021, yet a large number of legacy bonds and securitizations. contracts still refer to LIBOR, and new LIBOR contracts are still being CASE0155238_Report_Print Ready.indd 2 21/07/2020 12:07:01 Contents 04 | FSB 2019 Progress Report 20 | Remaining Challenges 05 | Adoption of RFRs in 22 | IBOR Transition LIBOR currencies Readiness Matrix 06 | Lack of IOSCO-compliant forward 25 | IBOR Jurisdiction term rates derived from RFRs 25 | UK/Sterling/SONIA 08 | Multiple-rate jurisdictions 26 | US/USD/SOFR 09 | Development of market conventions and information 28 | Euro zone/euro/€STR 10 | Legacy agreements 29 | Japan/Yen/TONA 12 | Derivatives 30 | Switzerland/CHF/SARON 15 | Enhanced scrutiny 31 | Australia/A$/AONIA 16 | Conduct and litigation risk 32 | Canada/C$/CORRA 18 | Key upcoming developments 33 | Hong Kong/HK$/HONIA and potential developments 34 | Singapore/S$/SORA 36 | Contacts CASE0155238_Report_Print Ready.indd 3 21/07/2020 12:07:39 FSB 2019 Progress Report In December 2019, the Financial Stability Board (FSB) stated that there had been “good progress” towards LIBOR transition in many derivatives and securities markets “but progress in lending markets has demonstrating how quickly these It may also be necessary to been slower, and needs to accelerate. important changes can take place upgrade systems to support use of A wide range of new products based once the necessary conditions are compounded RFRs in these markets.”1. on . [risk-free rates (RFRs)] has been established. Further foundational developed during 2019, while volumes steps such as raising awareness The FSB stressed that LIBOR transition in existing products have continued of the need for transition across a “now needs to accelerate, particularly to grow. Use of compounded RFRs wider range of cash market users in lending and securitisation markets.” has rapidly become the market are required to support transition in standard for new issuance of floating lending markets and will need to be rate securities in some markets, prioritised in the coming year. 1. FSB, Reforming major interest rate benchmarks, Progress report, December 2019. 4 CASE0155238_Report_Print Ready.indd 4 21/07/2020 12:07:39 Adoption of RFRs in LIBOR currencies Overnight RFRs have been identified for each LIBOR currency (and for the currencies of many other significant IBORs). Market participants can trade in overnight RFRs in each LIBOR currency now. Further, there now exist futures according to ISDA, aggregate SOFR For 2019, aggregate SARON traded contracts on exchanges for the RFRs traded notional was $392.7 billion, notional was $25.6 billion. Aggregate for Dollars, Sterling, euro and Swiss compared to aggregate traded traded notional for CHF LIBOR for Francs, SOFR, SONIA, €STR and SARON. notional USD LIBOR of $119 trillion. such period was $618.2 billion.6. The amount of liquidity in these Aggregate trading volume for SOFR markets varies by currency. futures was $30.8 trillion for the year.2. Despite growth in RFR interest rate derivatives, ISDA stated that “RFR According to the FSB report, the Cleared swaps volumes in €STR, TONA transactions continued to comprise aggregate market for cleared swaps (the RFR for Yen) and SARON lag their a small percentage of total IRD in SONIA is “broadly equivalent to LIBOR counterparts by more.3. trading activity, accounting for 3.4% that linked to LIBOR, with SONIA of IRD traded notional [in each of starting to dominate at shorter €STR is, of course, the relative 2018 and 2019].” maturities . The share of futures newcomer here, having only been referencing SONIA stands at around published since 2 October 2019. For There is evidence that market 7% of total sterling futures volumes.” 2019, aggregate €STR traded notional participants consider swaps For 2019, aggregate SONIA traded was $4.6 billion. Aggregate traded and derivatives markets for RFR notional was $8 trillion, according to notional for EUR LIBOR and EURIBOR alternatives in many LIBOR currencies ISDA, compared to aggregate traded for such period was $1.1 billion and to be immature (perhaps with the notional GBP LIBOR of $10.3 trillion. $22.9 trillion, respectively.4. sole exception of SONIA), and that Aggregate trading volume for SONIA LIBOR transition will require not futures was $8.7 trillion for the year. For 2019, aggregate TONA traded only a shift in swaps from LIBOR to notional was $249.8 billion. RFRs but also the development of The aggregate market for cleared Aggregate traded notional for JPY robust futures markets for RFRs.7. swaps in SOFR is much smaller LIBOR and TIBOR/Euroyen TIBOR for More particularly, market participants relative to the market for cleared such period was $3.985 trillion and are working to understand volatility swaps in USD LIBOR. For 2019, $10.5 billion, respectively.5. spikes in SOFR that occurred in 2019.8. 2. ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019. 3.ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019. 4.ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019. 5.ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019. 6. ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019. 7. See, e.g., “Banks Build New Tools to Shift Short-Term Borrowing,” Wall Street Journal, 26 January 2020. 8. See, e.g., “September stress in dollar repo markets: passing or structural?”, BIS Quarterly Review December 2019; “Central Bank Group’s Report Points to Deeper Problems in Repo Market,” Wall Street Journal, 11 December 2019; “Cash-Market Volatility Adds to Worries Facing Libor Replacement,” Wall Street Journal, 30 October 2019; “The Benchmark Set to Replace Libor Suffers Volatility Spike,” Wall Street Journal, 11 February 2019; and “After repo rates spike, leveraged loan investors raise concern about SOFR volatility,” S&P Global Market Intelligence, 26 September 2019. 5 CASE0155238_Report_Print Ready.indd 5 21/07/2020 12:07:39 Lack of IOSCO-compliant forward term rates derived from RFRs To date, no forward term rate derived from an RFR has been determined to comply with the IOSCO principles for benchmarks. These principles are reflected in the attention to overnight RFR LIBOR would emerge may have led some firms EU Benchmarks Regulation (BMR) replacements compounded in arrears to delay action in the loan markets. and include standards for robustness and the development of commercial and transparency, as well as a marked conventions to address these rates The LMA has published exposure preference for pricing information in transactions. Many SONIA and drafts of facility agreements for derived from actual transactions. SOFR floating rate notes (FRNs) use SONIA and SOFR compounded Regulators have urged firms not to compounded RFRs in arrears, and in arrears, and the LTSA has wait for these rates before transition. there have been some USD and published two concept credit Sterling securitizations that refer to agreements referencing SOFR in In the LIBOR jurisdictions, compliant these rates. arrears, one compounded and one forward term rates may emerge simple average.9. In a noteworthy from transaction data in OIS and Loan transactions have been slower transaction, Royal Dutch Shell futures markets after such markets to use RFRs in arrears. Among the announced that it had entered into develop sufficient volume and depth reasons for this seem to be lack of a syndicated USD 10 billion revolving (including as to longer maturities). borrower demand (borrowers like credit facility where LIBOR will be being able to set rates in advance, as replaced by SOFR as early as the first Because SONIA has existed since 1997 they can for LIBOR), and that screen anniversary of closing.10. In addition, and has a relatively mature trading rates do not yet exist.
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