Many global IBORs may not be available after the start of 2022 – the point at which regulators will no longer compel banks to submit short-term lending rates. While rates based on underlying money-market transactions – including Australia’s bank-bill swap rate (BBSW) – may survive, it is widely assumed that the days of many of the world’s most used benchmarks are numbered.

Global markets have developed over many years based on an assumption that the base rates underlying multifarious contracts are immutable. This is proving not to be a reliable truth in the medium-to-long term. How transition is managed will determine the extent to which the demise of IBORs introduces new risks to markets.

According to Moore, the true heart of the issue is hedging. Transition of individual products to new benchmark rates is a major task, but the real challenge lies in the fact that different parts of portfolios could transition in different ways.

Market users have been trying to establish the extent to which derivatives will move in the same way and at same time as cash products if there is no LIBOR. Quite often, Moore says, the answer is: not at all.

This is because the new rates that will be used in place of IBORs have fundamentally different characteristics so cannot simply be substituted for the expiring rates.

Historically, benchmark rates and fallback language did not contemplate a permanent cessation of LIBOR – just its absence for a day or a month. For instance, some popular fallback rates use the previous day’s LIBOR or an average of quoted interbank rates. These of course will not work if there is no LIBOR at all.

By contrast, most of the risk-free rates that are being explored as IBOR replacements are overnight and transaction based. In fact, a key aspect of market reform is moving away from expert judgement in rate setting.

New rates also tend not to have credit or term premia. Moore explained: “One big consequence of this is that rates will likely be set in arrears, so no-one knows what they will be until they are finalised for a period. This has pretty significant implications for systems, operations and the management of transaction lifecycle.”

The consequences of rates transition go beyond the narrow confines of capital markets, too. Some rates are used very widely and Moore says a key impact of transition lies in familiarity and optics in the retail sector, for instance around changing the pricing basis for mortgages. “If mortgage pricing changes from LIBOR plus 50 basis points to SOFR plus 75 basis points it certainly isn’t necessarily the case that retail borrowers will understand the nuances behind the move,” Moore commented. “The fact that LIBOR is in every nook and cranny of the US financial market while alternative rates are much less widely deployed is a key consideration in transition planning.”

Markets globally are at very different stages of progress in IBOR transition and indeed are eyeing different end points. Switzerland has completed its transition to a new risk-free rate, while Canada and Australia have made their existing benchmark rates more robust and have no plans to do away with them.

Moore says the work in jurisdictions that plan to stick with existing reference rates is focused on updating fallback language to cope with transition should it be required in future.

Elsewhere, there are questions about who should lead the transition process and how quickly market participants need to move. Moore argues that markets need to take on responsibility for themselves. “We don’t know what will happen after 2021 other than that banks will no longer be required to contribute to LIBOR pricing. In this context, there has not been a heavy-handed regulatory approach as yet.”

So far, the strategy market participants have tended to adopt is to inventory their portfolios and separate into legacy and new business. For legacy business, Moore says the most important issue is determining how to go about amending trades to reference new benchmarks.

While derivatives are 70-80 per cent of the LIBOR-related notional value in the US and get a lot of attention as a result, Moore says this market also has the advantage of coming under International Swaps and Derivatives Association protocols. “A new protocol is being developed and if adoption is universal conversion to new rates on set date becomes an operational challenge but no longer a legal one,” he told the delegates at the summit.

It is not the same for cash products. Moore added: “There will be some portion of trades that simply cannot be amended. We should all be going through the process of inventorying our risks and understanding what will happen when and if LIBOR is no more.”

Moore suggests market harmonisation would be optimal – but some issues remain unresolved. For example, one camp in the US would like LIBOR to remain and this option is being discussed “to some extent”. Regulators are less keen, says Moore, though the Intercontinental Exchange is trying to promote a solution that would let LIBOR or a LIBOR-like benchmark continue to exist.

Another option being explored is regulatory relief. Moore compares this to the EU’s transition to the euro, in which legacy currency holders were converted to euros at a fixed exchange rate. Under regulatory relief, US LIBOR contract holders would be transferred to the secured overnight funding rate at a set conversion rate. Moore believes this option will work for contracts where there is no good fallback language – of which there are a large number.

Regulatory divergence is also an issue. European benchmark regulation could deem LIBOR not fit for purpose and thus illegal. The US does not have equivalent regulation, so a unilateral Eurozone move would draw a line between markets.