By Gary Levin, Director, Head of Fixed Income Market Risk for Americas, Société Générale
What, for you, are the benefits of attending a conference like IBOR USA 2019 and what can attendees expect to learn from your session?
The topic of transition from Libor has been discussed for over a year. At this point, most market participants know the basics and can at least eyeball the affected processes in their organizations. The value of such conference then is to go beyond the basics and to hear the views of market professionals with respect to impacts on various market segments. Assuming transition is successful and legacy issues are fully addressed, there is still no clear understanding what markets would look like post-Libor.
What advice would you give to industry professionals trying to progress with LIBOR transition in an uncertain environment?
There are three aspects of Libor transition: 1) ability to trade new RFRs; 2) elimination of reference to Libor across trading, lending, hedging and funding books, and 3) understand the dynamics of new fixed income market. Most of the discussions are focused on the first two topics. I believe it would be prudent to pay a bit more attention to the last point – significant slices of fixed income market will behave quite differently post-transition and no one has a crystal ball on the impacts.
In your opinion, how could the changes to systems and rates impact liquidity and funding?
At this point, there is a lack of clarity of how the new markets would function. There may be a significant shift in liquidity between swaps and US Treasuries, for example. International funding markets, specifically expressed through cross currency swaps, may change their meaning. After all, what is a SOFR vs ESTR basis swap, when first rate is secured and second one is not? My suspicion is that cross currency basis market would lose liquidity, implying higher funding levels and more severe stresses. This may translate directly into USD funding markets due to the significant presence of international banks.
Do you think the transition will cause any changes to markets and trading post LIBOR? If so why?
There are specific slices of fixed markets which would change their behaviours. Examples include Swaps, loans / FRNs, etc. All these instruments will be directly impacted by removal of Libor reference. Our current understanding and modelling of various basis will need to be revisited. For example, what is the meaning of a Swap Spread in the new paradigm? Clearly, the new Spread is a different exposure than Swap Spread constructed using Libor swaps.
What will be the top challenges for IBOR over the coming 6-12 months?
We are at the critical juncture for Libor transition. Over the next year, unless massive amounts of cash instruments are issued and end customers begin getting used to new reference rates, the IBOR transition would stall. Losing current momentum could jeopardize transition efforts and negate the urgency which is emphasized by ARRC.
In addition, market participants continue to discuss alternatives to Libor other than SOFR – for example, a new credit sensitive index, etc. Stalled transition to SOFR could result in more alternatives proposed, adopted and traded. The side effect could be that market liquidity would be spread across multiple reference rates, resulting in overall drop in liquidity of hedging markets.