By Jacob Rank-Broadley, Head of LIBOR Transition, B&I, Refinitiv.
Refinitiv’s latest special report takes an in-depth look at the many remaining challenges that surround the imminent cessation of Libor, as well as the potential of data-driven solutions to enable a smooth transition.
A landmark transition
From the end of 2021, the FCA will no longer guarantee the production of the London Interbank Offered Rate (Libor). Libor will be replaced by a series of alternative risk-free rates (RFRs), including Sterling Over Night Index Average (SONIA) in the UK, Secured Overnight Financing Rate (SOFR) in the U.S., Euro Short-Term Rate (€STR) in the euro area and Swiss Average Rate Overnight (SARON) in Switzerland.
RFRs are primarily administered by Central Banks and supplemented by complementary rates such as term rates and fallbacks developed by private benchmark administrators.
As the Libor cessation deadline approaches, a new Refinitiv-sponsored special report warns that “settlement for trillions of dollars’ worth of legacy instruments could be thrown into disarray unless fixes are implemented before the end of 2021”.
According to the Financial Stability Board (FSB), the tools that are needed for the transition are already available, and this means that market participants should immediately move to finalise their plans. Moreover, they should do so with a sense of urgency if they wish to ensure an orderly and smooth transition.
Firms need to complete an array of tasks, ranging from the adoption of new benchmarks and technology upgrades, to the legal amendment of trillions of dollars of existing contracts tied to Libor. They must also ensure that they familiarise staff with all new conventions and tools, and provide adequate communication to counterparties and vendors.
|The Libor transition is “a mammoth, once-in-a-century operation to move away from the world’s most widely used interest rate benchmark that prices and values a wide range of financial products, including corporate and personal loans, mortgages, bonds, securitisations and derivatives.”
The last days of Libor, Are you ready for transition? – Special report 2021
Our report discusses some of the key areas that warrant attention within the broader Libor transition, including:
- Legacy contracts
There remains an urgent need to find solutions for legacy Libor contracts that lack robust fallback language and may potentially not be amended before the cessation of Libor. Whilst legislative solutions to help those contracts transition to the RFRs are being explored, legacy contracts remain a significant challenge.
- Cash products
Some cash products have not rapidly adopted RFRs as a result of certain key differences between these rates and Libor. Notably, Libor is a forward-looking term rate, whilst RFRs are backward-looking overnight rates. Secondly, unlike RFRs, Libor is an unsecured borrowing rate and includes the implied credit risk of the panel banks and a liquidity premium related to the length of the interest period. Solutions such as credit adjustments and term rates are already available to address these issues.
- Term rates as a transitional step
Term rates have an important role to play, with our report highlighting that “while regulators have been encouraging market participants to transition to RFRs rather than waiting for forward-looking term rates to emerge, the development of term rates can be an important transitional step”.
- Enhancements to swap rates
Benchmark administrators are also updating other benchmarks such as swap rates, which are vital for valuing swaptions and financial instruments. This means that market participants will need to find alternatives after the cessation of Libor.
- Liquidity building
The interconnectivity of markets means that cash markets need to transition to RFRs to facilitate sustainable growth in the derivatives market and vice versa. Whilst liquidity in RFR-linked derivatives is showing steady growth, the cash products market is lagging.
- Market data and operational risk
Firms need to minimise operational risk and should focus on the efficient sourcing of market reference data to drive the implementation of new rates.
A trusted partner
As an established benchmark administrator, Refinitiv’s comprehensive Libor transition and replacement rate solutions offer market participants support as they navigate these and other Libor-related challenges.
With many years of experience in designing, calculating, governing and publishing financial benchmarks, we have the depth and breadth of experience needed to support firms throughout the process – and consistently deliver the data, tools and analytics necessary for a smooth transition.
We publish term sterling overnight index average (SONIA) and the ARRC’s recommended US dollar fallback spreads and rates for cash products.
|Refinitiv delivers a powerful mix of news, data, tools and analytics underpinned by leading-edge, open platform technology to enable efficient planning and accurate impact assessments for a seamless Libor transition.|
As the final push to transition away from Libor gathers momentum, our report stresses above all that the time for action is now. Market participants should immediately take stock, review their transition plans and ensure that they have secured the data and support necessary to navigate the landmark transition that almost upon us.