SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx LIBOR Transition A practical guide December 2020 Edition December, 2020 1 SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx Table of Contents 1. LIBOR Transition: Executive Summary_______________________________________________ 4 What does this document seek to do? _________________________________________________ 4 Summary _________________________________________________________________________ 4 Practical considerations checklist ______________________________________________________ 4 Key highlights _____________________________________________________________________ 4 What's next? ______________________________________________________________________ 4 2. LIBOR Transition: Facts and Figures _________________________________________________ 5 What is LIBOR? ____________________________________________________________________ 5 Where is LIBOR used? _______________________________________________________________ 5 What is happening to LIBOR and by when? _____________________________________________ 5 What has the response been to date? __________________________________________________ 6 What are the main Alternative Reference Rates? _________________________________________ 6 How do these ARRs differ to LIBOR? ___________________________________________________ 8 Are these ARRs secured or unsecured? _________________________________________________ 8 Will the ARRs have forward looking term structures? _____________________________________ 8 What are ARR Compounded Index Rates? ______________________________________________ 8 What about the other IBOR Benchmark Rates? __________________________________________ 9 Summary and Practical Considerations _________________________________________________ 9 3. LIBOR Transition: Discounting Risk ________________________________________________ 10 What is discounting risk? ___________________________________________________________ 10 What changes have the CCPs made? _________________________________________________ 10 What are the implications for CSAs? __________________________________________________ 10 Why will these changes drive an increased Bilateral Negotiation of CSAs? ___________________ 10 When will UBS be ready to open CSA negotiations? _____________________________________ 11 What is the impact on swaption contracts? ____________________________________________ 11 Summary and Practical Considerations ________________________________________________ 11 4. LIBOR Transition: Forecasting Risk _________________________________________________ 12 What is Forecasting Risk? ___________________________________________________________ 12 What are the Fallback Provisions? ____________________________________________________ 12 What are some examples of differing fallback methods? _________________________________ 13 How will the LIBOR transition affect new contracts executed under the updated ISDA Definitions?13 How will the LIBOR transition affect the existing contracts? _______________________________ 13 2 SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx What is expected to happen to cleared contracts? ______________________________________ 14 How will the LIBOR transition affect products other than OTC derivatives? __________________ 14 How could hedge effectiveness across asset classes via linked transactions be affected by the LIBOR transition? _______________________________________________________________________ 14 What is the ISDA LIBOR to ARR adjustment? ___________________________________________ 14 What are the ARRC's recommended best practices? _____________________________________ 14 What is Pre-Cessation? _____________________________________________________________ 15 What is 'Synthetic LIBOR'? __________________________________________________________ 15 What are the implications of 'Synthetic LIBOR' on Transition? _____________________________ 15 What are the latest expected publication dates for LIBOR?________________________________ 16 Why is the Transition challenging for certain products? __________________________________ 16 Why might these Forecasting Risk changes drive increased bilateral/ multilateral negotiation? __ 16 What are the main drivers that may determine the impact on Forecasting Risk? ______________ 16 Summary and Practical Considerations ________________________________________________ 17 5. Regulatory and Market Milestones ________________________________________________ 18 6. Regulatory and Market Milestones Continued ______________________________________ 19 7. Appendix _______________________________________________________________________ 20 ARRC Recommended Best Practices __________________________________________________ 20 FINMA’s Recommendations and Transition Roadmap for 2021 ____________________________ 21 BoE RFR Working Group - Revised target milestones to manage transition away from Sterling LIBOR linked products by end 2021 ___________________________________________________ 23 Other IBORs Benchmark Rates _______________________________________________________ 25 Overnight Index Swap Industry Definitions _____________________________________________ 28 ARR detailed information ___________________________________________________________ 28 8. Bibliography ____________________________________________________________________ 29 9. Glossary ________________________________________________________________________ 31 10. Disclaimer _______________________________________________________________________ 32 11. Contact information _____________________________________________________________ 33 3 SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx 1. LIBOR Transition: Executive Summary What does this document seek to do? This guide aims to give UBS clients an understanding of the LIBOR transition and highlights the practical considerations that should be taken into account. This communication is not sent to you in connection with any wealth management, corporate or institutional client or asset management relationship you may have with UBS. Summary Regulators have announced that the market should stop relying on LIBOR. Each of the Alternative Reference Rates (ARRs) for the five major currencies (USD, EUR, GBP, CHF, JPY) involved is at a different stage in terms of development and liquidity. Other currencies' alternative rates are also being developed but the initial focus has been on these five. The industry needs to understand, prepare and execute with respect to this market change. LIBOR is used as a reference rate in a multitude of products and links, for example between a derivative and an underlying asset, need to be considered in order to understand potential basis risk between LIBOR and the new ARR. In addition to migration of transactions, industry changes in discounting methodology are underway and changes in technology systems may be required. UBS aims to keep clients informed of these changes and is running an extensive internal change programme focussed on this transition. Note that EURIBOR and TIBOR are expected to remain in the medium term so industry focus is on the other rates. Practical considerations checklist • Understand what this change means for you: – Analyse the exposure you currently have to LIBOR and assess the potential financial impact – Ensure you know where you have transactions which you believe to be linked (see Forecasting Risk Section) – Review the fallback language in your Legal Documentation (see Forecasting Risk Section) • Review your readiness: – Evaluate whether you need to make any changes to your risk management systems – In addition, consider any operational processes you may need to update, for example ensuring all reference data sources are updated accordingly – Consider consolidating your LIBOR exposure to reduce the number of bi-lateral transitions required Key highlights Facts and Figures Discounting Risk Forecasting Risk • 5 ARRs have been identified • Discounting rate and interest paid • Updated ISDA Definitions and IBOR to replace the 5 LIBOR on collateral usually aligned Fallbacks Protocol were published currencies • CCPs have now switched 23 October 2020 and become • Each ARR is an overnight rate discounting rates to ARRs and this effective on 25 January 2021 • The ARRs are backward is likely to be a key driver for • Differences in fallback methodology looking rates increased adoption of ARRs across different product types may • Adjustment methodology across the industry impact hedge effectiveness across agreed to address the • Any changes to the margin annex transactions believed to be linked differences (term and credit) for a derivative contract should • Evaluation of current contractual between LIBOR and ARRs reference the new ARR to replace fallback provisions may lead to existing cash margin rate increased bilateral discussion What's next? When relevant, UBS will be contacting you in due course on the following topics: • Trades with UBS referencing LIBOR; • Contracts with UBS which reference a transitioning benchmark If you have any further questions, in the first instance please contact your sales representative. Alternatively, please get in touch via [email protected]. 4 SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx 2. LIBOR Transition: Facts and Figures What is LIBOR? The London Interbank Offered Rate (LIBOR) is calculated from submissions by selected "panel" banks1 of the rates they either pay or would expect to pay to borrow from