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.
LEAVING LIBOR PART IV: APPROACHING YEAR END
Gregg Geffen (00:23):
Hello, and thank you for joining us. I am Gregg Geffen, head of JP Morgan's North America Corporate Interest Rate Derivatives Business, and I have the pleasure of hosting today's podcast. Joining me today are Tom Pluta, JP Morgan's Global Head of Linear Rates and Co-Head of North American Rates Trading, and Chris Palmer, Head of JP Morgan's firm-wide LIBOR Transition Program.
Gregg Geffen (00:44):
As we sit here in mid-November, we are now less than two months away from the end of new U.S. dollar LIBOR contracts in both cash products and derivatives. Over the past several months however, we've seen tremendous progress as it relates to benchmark interest rate reform. Today we will talk about the impact on a number of recent developments as well as several key items coming in 2022, and how clients can best prepare themselves for the transition.
Gregg Geffen (01:06):
With that, let's dive into the discussion. So Tom, this first question is for you. When we last spoke we were just about to get through the first phase of SOFR First. We've gone through a couple of phases now. I want to ask you, did SOFR First, in your view, have the effects at the market it was hoping it would have?
Tom Pluta (01:25):
Thanks, Gregg. Um, yeah, the SOFR First efforts were well designed, I think, and have gone quite well. Just to recap, what exactly this is, the Market Risk Advisory Committee of the CFTC, or the MRAC, along with input from the ARC, organized a series of, three dates corresponding to three different derivative product sets, um, from which all of the major bank dealers committed to trade only SOFR with each other in the interbank markets and not trade LIBOR. Um, in an effort to accelerate the transition off of LIBOR.
Tom Pluta (02:02):
So the first date was July 26th, and that's where we tackled the Interest Rate Swap Market. Um, and that went extremely well from the get-go, um, where the interbank volumes are about 90% SOFR with only about 10% LIBOR, so that's um, been really gone well. Um, the second date was September 21st and that was the Cross-Currency Swap Market. Um, so basically, any, you know, U.S. against sterling, U.S. against yen, Swiss or euro, Cross-Currency Markets um, went to, from LIBOR to RFR, also to interbank markets and that also went extremely well where almost overnight those markets went almost to 100% um, trading, in the alternative rates.
Tom Pluta (02:50):
And then the most recent one was November eighth, where non-linear products, specifically swaptions, caps and floors, um, in the interbank market went to SOFR First. And we're in the second week of it now and it's running at about 50 to 60% SOFR, which um, we're also happy with. I mean it's a more complex market, it'll take a little bit more time but we expect that to go from 60% um, you know, to, rise quickly in coming weeks. Um, there had been some contemplation of also doing a SOFR First date for Exchange-Traded Futures and Options, so euro/dollars. But um, you know, ultimately, the, that was, that's not going to happen.
Tom Pluta (03:35):
Um, and the reason for that is different from the Over-The-Counter Markets, the Exchange-Traded Markets, it's a different set of market makers, it's not the bank dealers that are the primary market makers. Um, for euro/ dollars that tends to be, you know, locals, uh, some High-Frequency Trading firms, some banks. So that effort really wouldn't have been effective in the same way, so that's not actually happening. But you know, overall, um, in the dates that we've had we consider them a big success. The percentages that I quoted are interbank volumes not client volumes, but the client volumes are following and increasing overtime. Um so the message is that the liquidity right now is excellent in SOFR. Uh, there's no reason for clients to delay if they have yet to be trading SOFR.
Tom Pluta (04:21):
Uh, and of course, you know, we do have the mandate that by the end of this year there should be no new SOFR business. So we are seeing the volumes increase, clients are coming along, it's all going quite well.
Gregg Geffen (04:33):
Chris, JP Morgan has been in the news recently for leading a number of major lending deals in SOFR. Why is this so important and what does it do for the broader markets?
Chris Palmer (04:44):
Thanks, Gregg. Well, it really does helps the broader market because it fits a precedence, and having had you know, hundreds conversations with our clients over the last couple years, the first question that we always get asked is you know, "What's the market pricing? What's the right market convention for our lending market?" And that's why we spend a lot of time talking to regulators around the importance of SOFR term rates. So the fact that we now have SOFR term rates available, we've been able to lead a few deals that have made, um, quite strong market publicity around, you know, what the right convention should be, how we incorporate a credit spread adjustment into these particular deals where the investors are happy to purchase those deals. What that's done, is it's really moved that market along quite a lot. There's no doubt that the lending market has been um, a follower to the derivative market, as Tom mentioned.
Chris Palmer (05:35):
The SOFR First initiative has been very successful, and the loan market has been much slower but that turns SOFR availability now and the fact that we've now got publicly available, you know, loans that are out there that clients and other participants to the [inaudible 00:05:50] market competitors can also start to copy. Uh, is actually been really, really positive. So it shows that JP Morgan's a leader in the market, it shows that our clients have an alternative now to move on to the alternate rates, which is really important. And it also, um, has allowed us to create a hedging market off the back of SOFR as well.
Chris Palmer (06:06):
So from that perspective we now have the end to end product set available, and as JP Morgan, as a strong leader in the market on this, it's really set a good foothold for our clients now to start to move forward on the transition. And the reality is, the more that, um, the market knows about what the forward market will look like, the easier the transition becomes, and the conversations with clients become much clearer. So, um, it's been really, really helpful to get those deals out to the market.
Gregg Geffen (07:10):
Uh so Tom, so Chris talked about the development of lending markets relative to SOFR, and specifically around term SOFR. Uh, we're seeing a derivatives market come along side that in CME term SOFR. But wanted to get your perspective, you know, if I'm a client can I do a CME term SOFR swap? Are there limitations on that? Um, you know, how's that broader market evolving?
Tom Pluta (07:32):
Yes, on the derivative side, um, term SOFR derivatives are only permissible to the extent that they are hedging a term SOFR cash product or portfolio of term SOFR cash products. So, um, you know, according to the best practices of the ARC is laid out, but also, and very importantly, it's a condition of the CME licensing agreement that everyone needs to sign to be able to use the rate. So, um, you know, there's very strict guidance there about how you can use it. Most of the inquiry that we've seen and the volumes that you expect are going to be um, loan market hedgers that are gonna pay fixed in term SOFR. Um, it's unclear at this point if we will see any off-setting received fixed flows, um, but at any rate um, it is ready to go.
Tom Pluta (08:26):
We are set up to trade today at JP Morgan, we have been working with some clients and we expect to be doing our first trades very, very soon. There are some challenges with this market. It will be a relatively small percentage of the market and, you know, as I highlighted it, it might be a little bit one way, where, um, you know, there isn't, um, an interbank market, there's not an ability for dealers to recycle risk, uh, so bank dealers will be holding the basis risk between term-self derivatives and compounded derivatives. But you know, that is what we do and, um, you know, we do expect the market, um, to be up and running very soon.
Chris Palmer (09:06):
Gregg, can I just add something to that around the license piece that, that Tom pointed out? So it's very important that our clients in the market, participants understanding that they are expected to hold a CME license for the use of term SOFR. That's a really important point. There's been much discussion around whether they do or don't need that and how that uh, particular rate will be used, whether they're calculating it or they're just receiving it, etc. But I think it's important to highlight that the expectation is that clients will need that. They should certainly clarify that, you know, with CME, but the expectation is that clients will need a term SOFR license to use that longer term.
Gregg Geffen (09:42):
No, it's, it's a good point and a subtle one so thank you for clarifying, Chris. This next question is, is for both of you, maybe we'll start with Chris on this. Let's fast-forward into 2022, not far away. Uh, U.S. dollar LIBOR will continue on as we know through the middle of 2023, um, but as a client as I look at next year, can I borrow or transact using these rates?
Chris Palmer (10:05):
You can transact in U.S. dollar LIBOR, but only for risk management and risk reduction purposes. So if we start, on the cash side first because I think that's a much easier conversation. The short answer is no, you can't deal in U.S. dollar LIBOR in 2022. The expectation is that all new dealing and all new loans should be an alternate rate. There are many rates available. Um, there's been much communication from the various regulators around the globe on this particular top point and particularly from our uh, U.S. regulators, the OCC, the Fed, etc. but have issued multiple elements of guidance on this point. And they've also made it very clear they will monitor this very closely.
Chris Palmer (10:46):
Um, from a bank perspective, for example, we are obliged to record all our different transactions that we'll do on, um, U.S. dollar LIBOR in 2022, and make sure that we are meeting the obligations under that guidance around that we are using them for risk management and risk production purposes. So from a, a trading perspective, yes you can and I'll certainly let Tom go into a little bit more detail about that. But the point that we really want to emphasize here is that no new LIBOR dealing should be completed. And if there's a debate in your mind around is it new or isn't it new really the focus should be, it is new and therefore you shouldn't be doing it.
Chris Palmer (11:22):
So I think that's really important to, to try and think about because there's, you know, there's been many market participants that have asked for great clarity on this but the regulators have provided about as much clarity as they, as they're going to. So ultimately, it's you as a market participant need to make that decision. But I can assure you from we as JP Morgan, we will um, abide by the guidance that's being provided by the regulators.
INSERT TAKE FROM 22:01 Tom Pluta (22:01):
In the derivatives markets as well, the mandate is very clear. No new LIBOR after the end of this year, and we, we all of course comply with that. The exceptions are for risk reducing trades. So, examples of that are, um, LIBOR portfolios that are being converted to SOFR. Trades that are being unwound. Compression of portfolios of derivatives, which is quite common, uh, or hedging fixing risks. So, that's on our own portfolios, we're facilitating that for clients. So, they will be legitimate LIBOR trading after the end of this year, but those amounts will be modest and declining over the course of '22, and certainly heading into '23 towards the succession date on June 30th, of '23.
Tom Pluta (22:45):
Um, it won't be feasible for bank dealers to really police what end users are doing. It's up for end user clients to make those representations, and make sure that they are complying with the no new LIBOR mandate and answering to their own regulators as we're answering to the Fed, the OCC, the FDIC etc. Gregg Geffen (13:20):
Thanks, both. So just to sum it up though, no new LIBOR risk that is not uh, uh, otherwise limiting systemic risk starting at the end of this year, so basically in- in six weeks time. Um, so I think it's an important point that you know, no matter how much we put it out there just can't say it enough.
Tom Pluta (13:36):
Gregg Geffen (13:38):
Maybe just turning to a couple of questions around uh, Tough Legacy and- and you know, broader legacy deals. Um so Chris, maybe we'll start with you. There's been some development in fact today on synthetic LIBOR rates. Um, so GBP and yen LIBOR will continue to publish on a synthetic basis. Can clients use these rates for new business that they do? And can- can legacy contracts leverage these rates as well?
Chris Palmer (14:02):
Yeah, let's start with the- the first question, and- and the answer is no. So these rates are what we call unrepresentative rates under BMR or Benchmark Regulations. So what that means is, it means that they are not benchmark compliant, they are only there to facilitate the transition away from LIBOR, and to ease the transition. So, no new deals can be done, be they derivative or loans or any other securities, for example, so we should not expect to see any new deals executed using a synthetic LIBOR rates. What we can do, and what this legislation provides for is, the allowance of a, of a transition for up to 12 months.
Chris Palmer (14:38):
So if you've got, you know, for example, if you've got seven, or eight, or nine months left on your existing deal, then it might be easier to just let the, um, deal flow using the synthetic LIBOR rates. And the synthetic LIBOR rates is the term rate plus the spread, the [inaudible 00:14:57] spread. So it'll be in the sterling market it would be termed SONIA and in the yen market it's um, TOR, which is effectively the term Turnout Rate.
Chris Palmer (15:06):
So the FCA have confirmed that they will allow them to be used for the next 12 months. Um, certainly we know that the yen market will only have a synthetic LIBOR rate for the next 12 months. There is some debate about whether uh, longer term, we may still have a synthetic GDP rate, but the legislation is very clear that the FCA have the right to review that after 12 months and can sit [inaudible 00:15:31] at that point in time. So really what this is is a push for the market participants. It's giving you an extra 12 months to allow a trans-, an easy transition, but you can't rely on this longer term. That's a really important point.
Chris Palmer (15:44):
And the FCA again, has made it very clear in their guidance that they do not want to see um, effectively no action taken, everyone just sort of defaults that. It's only about 3% of the market now that hasn't already signed these protocol, or come up with a, a transition solution already, so it's a very small part of the market, and again the FCA would like to make sure that uh, it's only used for a small por- portion of the market moving forward.
Chris Palmer (16:06):
So although, we- we have had some clients we need to be open we have had some clients who say that they won't necessarily remediate their documents and they'll just use synthetic LIBOR, but that's more for the RCFs that we haven't realized revolving credit facilities where they have an option to draw in these currencies and have decided actually that it's easier that they, hands off the keyboard, they won't do anything. And if they were to draw then they could use this. But the reality is if they don't draw out until the end of the year, most of that documentation actually reverse to new rate anyway. So there's uh, effectively a draw stop component compiled into a lot of those RCFs, so you can't actually use those rates. They will, it will automatically convert you to a SONIA or to a [inaudible 00:16:45] in the Swiss market, etc.
Chris Palmer (16:47):
So there's a lot of in-built controls that are already in the market, but this will help for some of those securities in particular which are a- a bit longer dated where the ability to receive consent is much more difficult, so the ability to use the synthetic LIBOR for those legacy deals um, will help with the transition.
Gregg Geffen (17:06):
So Tom, along the same lines, what do you say to a client that says you know, "I don't want to move to SONIA or to TONAR? I'll just stay on this synthetic LIBOR rate."
Tom Pluta (17:16):
Well, what I would say to them, or it's important to remember that synthetic LIBOR will only last for one year. So, clients would need to use 2022 to either unwind or restructure the trade or to add appropriate fallback language to, to a new rate within the timeframe. Um, clients shouldn't assume that the problem is solved because we have a synthetic LIBOR but it's more a one year breather to resolve some of these, um, some of these issues. Um, and you know, as Chris mentioned, we have TONAR, we have SONIA, these are good rates. It's, it's in your best interest to move forward and get onto these rates as soon as possible.
Gregg Geffen (17:55):
Thanks, both of you. Um, that's the end of my questions, so be- before we wrap, I wanted to see Chris and Tom, if there's anything else that you feel is, is important to our listeners that we didn't get through today?
Chris Palmer (18:06):
The only other point that, uh, I mean is worth talking about is the, the legislation in the US is progressing quite well. So we do hope that we also have some form of a synthetic LIBOR or effectively a legislation so- solution for our US dollar market. So, that is progressing well. Um, we don't have a date of when that may be um, formally approved. But the point is that the US market is also looking at, at a similar type of solution, which we hope, um, we hope will be available for the transition. But the scope of products is expected to be much less. It is expected to, to not include the derivative market for example, and some of the loan market. So, that's just to, to be aware that that is an ongoing process. And certainly in our next podcast we will be able to give more detailed update on the progress of that.
Tom Pluta (18:50):
Yes, good, good point on the federal legislation. I guess what I would add, is as we try to say every time we do one of these things, um, time is short, it's only six weeks to go. Uh, we've seen a lot of transition, the products are all set. The [inaudible 00:19:04] is number one certainty and the liquidity is there, so, um, don't delay, and, uh, encourage everyone to, to transition as quickly as possible with the, with the end in sight.
INSERT TAKE FROM 21:01 Gregg Geffen (21:01):
I think that's a good place to end it. Tom, Chris, thank you both for your time today and for, for sharing your perspectives as always. Uh, thank you to all of our listeners. We hope that today's podcast was timely and informative. You know, as always we want to make sure all of our clients feel knowledgeable on the issues and prepare for the transition to SOFR. So we want to ensure that you're connecting with your JP Morgan colleagues to understand the impact on your organization. So, with that, thank you all again for joining us. We look forward to you joining us again the next time, and we hope that you have a great rest of your days.
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.
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.
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Country Specific Disclosures
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