Libor transition: crunch time
Differing levels of progress across global jurisdictions toward the end goal of LIBOR cessation demonstrates both that a successful transition is possible and that pitfalls await for those that do not move swiftly enough. There are lessons for Australia and New Zealand in how international markets have adapted to benchmark change.
The demise of LIBOR has been planned for a matter of years. But momentum toward preparing for a post-LIBOR market environment has been slow to develop in at least some jurisdictions.
Work on identifying alternative benchmark rates commenced soon after the LIBOR fixing scandal blew up in 2012, and the key decision in the whole process – the UK Financial Conduct Authority (FCA)’s determination that it would no longer mandate LIBOR price submissions after the end of 2021 – happened in July 2017.
This decision effectively fixed a date at which some global interest-rate benchmark rates – perhaps most notably sterling and US dollar LIBOR – would cease to exist. For players active in these markets, the past four-years-plus should have incorporated a degree of planning for future usage of alternative reference rates (ARRs) rather than the interbank benchmarks that have underpinned market activity for decades.
Other jurisdictions have been able to play the waiting game – but to varying degrees. The Eurozone’s established benchmark, EURIBOR, does not have a set cessation date but regulators are certainly moving in the direction of having robust ARRs available. Australia reformed its interbank benchmark, BBSW, to the extent that market participants and regulators believe it is for the most part fit for ongoing use. Even here, though, many observers believe BBSW may not have a long-term future.
With a few months to go until the final deadline, it is clear that significant progress has been made – but not across the board. “We talk about the LIBOR transition as if it is a single thing, but the reality is each of the individual currencies is in a very different place,” explains Jacob Rank-Broadley, London-based head of LIBOR transition at Refinitiv’s benchmarks and indices business.
The good news is that some market sectors in the UK demonstrate that it is possible to complete the heavy lifting needed to move market infrastructure from a term interbank benchmark rate to an overnight risk-free rate (RFR), and from there to develop a term version of the RFR.
Term rates were a major bugbear in the early days of LIBOR transition and their absence made the switch from pricing based on, for instance, three-month LIBOR even harder. The path has cleared, however. For instance, Refinitiv’s term SONIA rate went live in January this year, offering market participants forward-looking one-, three-, six- and 12-month benchmarks.
In the cash-bond market, Refinitiv data show that sterling-denominated floating-rate notes issued since August last year are now fives times more likely to reference SONIA than sterling LIBOR.
“If you ended the story at the transition from sterling LIBOR to SONIA, you would conclude that it was a very smooth, hugely successful project,” Rank-Broadley tells KangaNews. “Most bond and derivative market participants now understand the materiality of this change and are extremely well prepared, so everything is lined up very well.”
It is a different story in other jurisdictions and even in other sectors in the UK. In the loan market, for instance – in the UK and US – Rank-Broadley says plenty of participants are still not clear on their approach post-LIBOR, while the concept of “tough legacy” contracts has not been fully resolved by UK regulators.
In this case, Refinitiv has been selected by the US Alternative Reference Rate Committee (ARRC) to publish its recommended spread adjustments and spread-adjusted rates for cash products. These fallback rates should ease the transition away from LIBOR by providing an economically equivalent rate that can support the continued existence of the – ARRC estimated – US$1.9 trillion of tough-legacy contracts following the demise of LIBOR.
Unusually among global interbank rates, there is still reasonable volume of physical trading in the interbank market underlying BBSW. Its ongoing robustness depends on this continuing, however – and the equivalent markets have all but evaporated in most global jurisdictions. Meanwhile, central banks in general have not been pleased to see interbank credit benchmarks spiking in volatile market periods during which they have been trying to push down the price of credit in the real economy.
Eyes will be on the UK and US at the start of 2022. “If we see the LIBOR transition being a very smooth process I think it will encourage other regulators to proceed,” Rank-Broadley suggests. “If transition has a rough patch at the beginning of next year and causes serious problems, I think it will dent the confidence of regulators in other jurisdictions to tackle a similar exercise.”