Four years have passed since the U.K. Financial Conduct Authority (FCA) announced that it would no longer persuade or compel contributing banks to publish the London Interbank Offered Rate (LIBOR) rate after 2021. This announcement started a global conversation among financial institutions on how to transition an estimated $400 trillion in assets across currencies including the British pound, Japanese yen, Swiss franc, euro and U.S. dollar away from LIBOR and toward risk-free rates (RFRs). With less than one month of LIBOR publication remaining across most major currencies, now is the time to ensure your organization is ready for trading without LIBOR.
With guidance from global regulatory bodies and national working groups, the journey away from LIBOR has already started. To ensure a smooth and effective shift from LIBOR, financial institutions have established LIBOR transition programs and industry working groups have been created to promote best practices and common conventions.
This transition has raised uncertainties and challenges across the industry. One major concern was lack of RFR liquidity in the derivatives market. To increase liquidity, the Sterling Overnight Index Average (SONIA) First, Secured Overnight Financing Rate (SOFR) First and Tokyo Overnight Average Rate (TONA) First initiatives were launched in the U.K., U.S. and Japan, respectively. Since these initiatives went live, daily trading volumes referencing RFRs have been exceeding those referencing LIBOR in GBP and JPY, with USD almost at 50% of the overall market. Ninety-five percent of interdealer USD activity is now tied to SOFR, with just 5% on LIBOR. These initiatives helped to push liquidity to levels that enable an active transition away from LIBOR and onto the RFR.
The LIBOR cessation dates gained further clarity on March 5, 2021, when the FCA formally announced the cessation of one-week USD, 2-month USD, GBP, JPY, CHF and EUR LIBOR rates after December 31, 2021, with the remaining USD LIBOR settings to cease after June 30, 2023. Prior to this, the Fed, OCC and FDIC had released a joint statement making it clear that no new USD LIBOR contracts would be permitted after the end of 2021. Limited exemptions are allowed only for risk management purposes. There is significant regulatory oversight in making sure these timelines are met, with no new contracts written referencing these rates after 2021.
The market needed forward-looking term rates to become available for use, especially within the USD market. For certain users, it is difficult to use the compounded in arrears format due to operational complexity and/or lack of systems compatibility. However, more importantly, certain users need to know the rate of payment in advance of the interest period to enable more effective liability management. Forward-looking term rates are now published for SOFR, SONIA and TONA to allow certain markets to transition away from LIBOR where use of an overnight rate is impractical. Lack of forward looking-term rates is not an excuse to delay transition away from LIBOR.
Industry working groups have published materials and tools to assist with legacy contracts tied to LIBOR. The International Swaps and Derivatives Association (ISDA) and Alternative Reference Rates Committee (ARRC) released recommended fallback language for derivatives and cash products, respectively. For derivatives, counterparties who have both adhered to the ISDA IBOR 2020 Fallbacks protocol will automatically have IBOR fallback language included in legacy and new contracts falling under the ISDA master agreement. For cash products, the ARRC published recommended fallback language for adjustable rate mortgages, bilateral business loans, syndicated loans, floating rate notes, securitizations and variable rate private student loans. The Loan Market Association published its “Replacement of Screen Rate Clause” and “Supplement” language, which lowers the consent threshold required for parties to a syndicated facility to agree on a replacement benchmark ahead of cessation. It is up to now up to market participants to take the appropriate steps to review and incorporate fallback language, whether that is through the use of ISDAs 2020 IBOR Fallbacks Protocol for derivatives or to bilaterally agree to adopt recommended fallback language in certain contracts. Market participants should further ensure that internal systems can transition contracts to alternative benchmarks once fallback triggers are activated.
One of the most recent developments occurred for “tough legacy” contracts. These are contracts that are very difficult to renegotiate or to insert robust fallback language. The FCA and Bank of Japan have consulted on Synthetic LIBOR and its use in tough legacy contracts, confirming that 1, 3, and 6 month GBP and JPY Synthetic LIBOR rates will be available at least through 2022, with JPY ceasing at the end of 2022. Note: Synthetic LIBOR will not be published indefinitely and FCA reserves the right to change the course or stop the publication of Synthetic LIBOR. It is important to highlight that the regulatory expectation is for market participants to continue transitioning to RFRs and to avoid reliance on Synthetic LIBOR.
With all the developments in the LIBOR transition arena, market participants no longer have any reason to delay transitioning across all markets and products. The information needed to move away from LIBOR is publicly available, and facilitators, including your banking representatives, should be able to clarify any points of concern. All market participants have a degree of responsibility to ensure that the transition from LIBOR is completed successfully. There is just over one month left until the end of LIBOR for most major currencies. Take action now.
Hear the latest developments in Secured Overnight Financing Rate markets and drivers for improvements in liquidity. Thomas Pluta, Global Head of Linear Rates Trading, and Chris Palmer, Head of the LIBOR Transition Program, join Greg Geffen, Head of North America Corporate Interest Rate Derivatives, to discuss the regulatory guidance to cease initiation of new use of USD LIBOR products.
This podcast was recorded on November 16, 2021.
The views in this podcast do not necessarily reflect the views of JPMorgan Chase and Co or its affiliates. Collectively JP Morgan. This communication is provided for information purposes only. JP Morgan normally makes a market and trades as principal insecurities, other financial products and other asset classes that may be discussed in this for additional disclaimers and regulatory disclosures. For additional disclaimers and regulatory disclosures, please consult: https://www.jpmorgan.com/disclosures/salesandtradingdisclaimer. For further information about benchmark reform and the transition away from LIBOR, please visit LIBOR Primer: Setting the stage for SOFR.
Markets
March 29, 2023
The move away from the London Interbank Offered Rate (LIBOR) is a global phenomenon that has the financial industry mobilizing ahead of a looming deadline.
Markets
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