By Alaistair Sharp, Head of Short Term Interest Rate Trading London, Credit Suisse
What, for you, are the benefits of attending a conference like the ‘IBOR Europe’ and what have attendees learnt from your session?
The benefit of attending the ‘IBOR Europe’ conference is to get a better picture of what is actually happening in IBOR transition and what are the likely paths that the market will follow. All the literature, especially from official bodies, highlighted the official path that is being championed by the official sector, but tended to miss some of the issues and problems being encountered.
What advice would you give to risk professionals when working across multiple jurisdictions and major currencies?
My advice would be to make sure you don’t assume that IBOR transition will have consistent implications in different jurisdictions. You will need to contemplate the risks that different jurisdictions are not consistent with regards to IBOR transition and look at your options for mitigating these risks. Finally you should make sure you advocate strongly for a consistent approach to transition across jurisdictions where possible, and if you are told that this is not possible, demand a thorough explanation to ensure that your interests are being correctly represented. It may be that consistency is not particularly important compared to some other factors.
Why are variations in rate behaviour a key concern?
Some currencies plan to remain on IBORs. For example, EURIBOR is not due to end for the time being and so contracts will remain on an ex-ante Fixing Rate, whereas USD LIBOR is expected to end in 2021 and the market will start using an ex-post Realised SOFR Rate. Thus any cross currency basis swaps, for example, would use a rate known in advance on the EUR leg of a trade, while a realised rate, only known at the end, on the USD leg. This might create risk management issues that don’t currently exist.
Additionally, some of the ARR are unsecured benchmarks while others are secured benchmarks. They don’t both display the same characteristic behaviour. As has become clear by the recent blow out in SOFR rates in September, secured benchmarks tend to display more idiosyncratic behaviour. If you are using both secured and unsecured benchmarks to mitigate risks in different currencies, you need to be aware of these differences.
What are the key concerns when it comes to changes in pricing?
ARR are overnight rates and thus contain no credit or liquidity premium. This is why they are known in Europe as Risk Free Rates (RFR). Therefore any unfunded facilities will be inherently more risky to the lender, as borrowers will be more likely to drawdown on their facility as funding costs escalate. To compensate, lenders will likely have to charge more to compensate for this higher risk. How much they need to charge though is unclear.
Additionally, it will be harder for borrowers to know whether any additional margin over the ARR is consistent with market funding conditions or simply an additional profit margin for their lender. Unfortunately, in the absence of a Bank Credit benchmark, there isn’t any easy way to monitor this. However, IBA (the administrator of LIBOR) plans to launch a new bank credit benchmark for USD called the ICE Bank Yield Index (ICE BYI) which they have shown closely mirrors current USD LIBOR. The ICE BYI could therefore provide a possible replacement benchmark for those end users who still required the credit and liquidity premium elements inherent in LIBOR.
In your opinion, what will be the industry triggers of when LIBOR will end?
At the moment I think that the most likely trigger will be a notice from an official body such as the FCA determining that LIBOR is no longer representative rather than the termination of publication of the benchmark. What criteria they might use to determine this is fairly unclear as the FCA have refused to specify what specific criteria they would choose to evaluate this trigger. Additionally it would be hard to argue that the replacement LIBOR Fallback would be any more representative than the current LIBOR rate so the decision will likely refer to the risk that publication of the benchmark could be compromised as they could no longer guarantee the continued support from LIBOR panel banks after the end of 2021. As such, I envisage that this announcement will occur towards the end of 2021.
Finally, it is possible that this announcement might not mean the end of LIBOR as it might linger on as a so-called “Zombie” LIBOR for “difficult legacy”, but the majority of contracts that reference LIBOR would have “fallen-back” into a rate that references the chosen ARR.