LIBOR'S LONG GOODBYE - TRANSACTIONAL POWERHOUSE - READINESS FOR LIBOR TRANSITION - BAKER MCKENZIE

 
LIBOR'S LONG GOODBYE - TRANSACTIONAL POWERHOUSE - READINESS FOR LIBOR TRANSITION - BAKER MCKENZIE
LIBOR’S LONG GOODBYE
Readiness for LIBOR transition

TRANSACTIONAL
POWERHOUSE
                                 1
Introduction                                                                                                                    Contents
As has been noted in a continuous drumbeat of warnings from major                                                               04 | FSB 2019 Progress Report           20 | Remaining Challenges
global, regional and local regulatory bodies, LIBOR is expected to go away
at the end of 2021, when the UK Financial Conduct Authority (FCA) has                                                           05 | Adoption of RFRs in               22 | IBOR Transition
announced it will withdraw support for the rate.                                                                                     LIBOR currencies                        Readiness Matrix

                                                                                                                                06 | Lack of IOSCO-compliant forward   25 | IBOR Jurisdiction
This deadline was first announced           This report also includes a matrix       written, in each case that mature
in a speech by Andrew Bailey, chief         showing an assessment of readiness       after 2021. The official sector
                                                                                                                                     term rates derived from RFRs
executive of the FCA, in July 2017.         for transition by currency and product   of regulators and central banks                                                         25 |   UK/Sterling/SONIA
Since more than half of the roughly         type. As we’ve noted previously,         continues to stress the need to            08 | Multiple-rate jurisdictions
four-and-a-half-year-period that that       LIBOR transition is at different         develop robust alternative reference
speech gave until the deadline has          stages of progress in different          rates and robust contractual fallbacks                                                  26 |   US/USD/SOFR
now elapsed, it is perhaps fitting to       jurisdictions and with respect to        in the event that LIBOR were to            09 |	Development of market
consider how far markets have come          different financial products.            cease or become unrepresentative                conventions and information             28 |   Euro zone/euro/€STR
in LIBOR transition, and how much                                                    of underlying financial reality, and to
further they need to go.                    LIBOR transition remains a               transition to such alternative rates.
                                            fundamental issue confronting            Despite the uncertainty that exists, the   10 | Legacy agreements                       29 |   Japan/Yen/TONA
This report assesses the state of           financial markets. To date, transition   FCA has stated firmly that the end-2021
readiness for transition from LIBOR         has been slower than regulators          deadline remains in effect, a statement
(and other interbank offered rates          would like, and considerable             it reiterated on 25 March 2020 in          12 | Derivatives                             30 |   Switzerland/CHF/SARON
(IBORs)) to alternative interest rates      uncertainty still exists (and may        response to the Covid-19 pandemic.
in the jurisdictions of each LIBOR
currency (and select other jurisdictions)
                                            well remain for some time). Time
                                            is growing shorter until the end of
                                                                                                                                15 | Enhanced scrutiny                       31 |   Australia/A$/AONIA
with respect to derivatives, loans,         2021, yet a large number of legacy
bonds and securitizations.                  contracts still refer to LIBOR, and                                                 16 | Conduct and litigation risk             32 |   Canada/C$/CORRA
                                            new LIBOR contracts are still being

                                                                                                                                18 |	Key upcoming developments              33 |   Hong Kong/HK$/HONIA
                                                                                                                                     and potential developments
                                                                                                                                                                             34 |   Singapore/S$/SORA

                                                                                                                                                                        36 | Contacts
FSB 2019                                                                                                                           Adoption of RFRs
    Progress Report                                                                                                                    in LIBOR currencies
    In December 2019, the Financial Stability Board (FSB) stated that there                                                            Overnight RFRs have been identified for each LIBOR currency (and for the
    had been “good progress” towards LIBOR transition in many derivatives                                                              currencies of many other significant IBORs). Market participants can trade
    and securities markets                                                                                                             in overnight RFRs in each LIBOR currency now.

     “but progress in lending markets has          demonstrating how quickly these           It may also be necessary to               Further, there now exist futures                according to ISDA, aggregate SOFR                For 2019, aggregate SARON traded
    been slower, and needs to accelerate.          important changes can take place          upgrade systems to support use of         contracts on exchanges for the RFRs             traded notional was $392.7 billion,              notional was $25.6 billion. Aggregate
    A wide range of new products based             once the necessary conditions are         compounded RFRs in these markets.”1.      for Dollars, Sterling, euro and Swiss           compared to aggregate traded                     traded notional for CHF LIBOR for
    on . . . [risk-free rates (RFRs)] has been     established. Further foundational                                                   Francs, SOFR, SONIA, €STR and SARON.            notional USD LIBOR of $119 trillion.             such period was $618.2 billion.6.
    developed during 2019, while volumes           steps such as raising awareness           The FSB stressed that LIBOR transition    The amount of liquidity in these                Aggregate trading volume for SOFR
    in existing products have continued            of the need for transition across a       “now needs to accelerate, particularly    markets varies by currency.                     futures was $30.8 trillion for the year.2.       Despite growth in RFR interest rate
    to grow. Use of compounded RFRs                wider range of cash market users          in lending and securitisation markets.”                                                                                                    derivatives, ISDA stated that “RFR
    has rapidly become the market                  are required to support transition in                                               According to the FSB report, the                Cleared swaps volumes in €STR, TONA              transactions continued to comprise
    standard for new issuance of floating          lending markets and will need to be                                                 aggregate market for cleared swaps              (the RFR for Yen) and SARON lag their            a small percentage of total IRD
    rate securities in some markets,               prioritised in the coming year.                                                     in SONIA is “broadly equivalent to              LIBOR counterparts by more.3.                    trading activity, accounting for 3.4%
                                                                                                                                       that linked to LIBOR, with SONIA                                                                 of IRD traded notional [in each of
                                                                                                                                       starting to dominate at shorter                 €STR is, of course, the relative                 2018 and 2019].”
                                                                                                                                       maturities . . . . The share of futures         newcomer here, having only been
      1.
           FSB, Reforming major interest rate benchmarks, Progress report, December 2019.
                                                                                                                                       referencing SONIA stands at around              published since 2 October 2019. For              There is evidence that market
                                                                                                                                       7% of total sterling futures volumes.”          2019, aggregate €STR traded notional             participants consider swaps
                                                                                                                                       For 2019, aggregate SONIA traded                was $4.6 billion. Aggregate traded               and derivatives markets for RFR
                                                                                                                                       notional was $8 trillion, according to          notional for EUR LIBOR and EURIBOR               alternatives in many LIBOR currencies
                                                                                                                                       ISDA, compared to aggregate traded              for such period was $1.1 billion and             to be immature (perhaps with the
                                                                                                                                       notional GBP LIBOR of $10.3 trillion.           $22.9 trillion, respectively.4.                  sole exception of SONIA), and that
                                                                                                                                       Aggregate trading volume for SONIA                                                               LIBOR transition will require not
                                                                                                                                       futures was $8.7 trillion for the year.         For 2019, aggregate TONA traded                  only a shift in swaps from LIBOR to
                                                                                                                                                                                       notional was $249.8 billion.                     RFRs but also the development of
                                                                                                                                       The aggregate market for cleared                Aggregate traded notional for JPY                robust futures markets for RFRs.7.
                                                                                                                                       swaps in SOFR is much smaller                   LIBOR and TIBOR/Euroyen TIBOR for                More particularly, market participants
                                                                                                                                       relative to the market for cleared              such period was $3.985 trillion and              are working to understand volatility
                                                                                                                                       swaps in USD LIBOR. For 2019,                   $10.5 billion, respectively.5.                   spikes in SOFR that occurred in 2019.8.

                                                                                                                                          2.
                                                                                                                                             ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019.
                                                                                                                                          3.
                                                                                                                                             ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019.
                                                                                                                                          4.
                                                                                                                                              ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019.
                                                                                                                                          5.
                                                                                                                                             ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019.
                                                                                                                                          6.
                                                                                                                                              ISDA, Interest Rate Benchmarks Review: Full Year 2019 and the Fourth Quarter of 2019.
                                                                                                                                          7.
                                                                                                                                            See, e.g., “Banks Build New Tools to Shift Short-Term Borrowing,” Wall Street Journal, 26 January 2020.
                                                                                                                                          8.
                                                                                                                                               See, e.g., “September stress in dollar repo markets: passing or structural?”, BIS Quarterly Review December 2019; “Central
                                                                                                                                                Bank Group’s Report Points to Deeper Problems in Repo Market,” Wall Street Journal, 11 December 2019; “Cash-Market
                                                                                                                                                Volatility Adds to Worries Facing Libor Replacement,” Wall Street Journal, 30 October 2019; “The Benchmark Set to Replace
                                                                                                                                                Libor Suffers Volatility Spike,” Wall Street Journal, 11 February 2019; and “After repo rates spike, leveraged loan investors raise
                                                                                                                                                concern about SOFR volatility,” S&P Global Market Intelligence, 26 September 2019.

4                                                                                                                                                                                                                                                                                     5
Lack of IOSCO-compliant forward
    term rates derived from RFRs
    To date, no forward term rate derived from an RFR has been determined
    to comply with the IOSCO principles for benchmarks.

    These principles are reflected in the     attention to overnight RFR LIBOR         would emerge may have led some firms      Some regulators (including the FSB’s          likely operationally achievable for             The OSSG has also suggested that,
    EU Benchmarks Regulation (BMR)            replacements compounded in arrears       to delay action in the loan markets.      Official Sector Steering Group (OSSG))        approximately 90% of the total value            over time, liquidity would likely
    and include standards for robustness      and the development of commercial                                                  have expressed the view that use              of the Sterling LIBOR loan market,              concentrate in markets that focused
    and transparency, as well as a marked     conventions to address these rates       The LMA has published exposure            cases for forward term rates should           and that the remaining 10% would                on overnight RFRs, and that markets
    preference for pricing information        in transactions. Many SONIA and          drafts of facility agreements for         be limited.12. The Working Group on           likely require a term rate or other             that currently used term rates
    derived from actual transactions.         SOFR floating rate notes (FRNs) use      SONIA and SOFR compounded                 Sterling Risk-Free Reference Rates            rate. Loans for sponsors and large and          might well migrate to the overnight
    Regulators have urged firms not to        compounded RFRs in arrears, and          in arrears, and the LTSA has              (Sterling Working Group) has stated           medium-sized corporates are within              markets for pricing reasons, since
    wait for these rates before transition.   there have been some USD and             published two concept credit              that the use case for a forward term          the 90%. Trade and export finance,              the concentrated liquidity might
                                              Sterling securitizations that refer to   agreements referencing SOFR in            SONIA rate should be limited relative         which often use discounting, and                well result in tighter spreads. The
    In the LIBOR jurisdictions, compliant     these rates.                             arrears, one compounded and one           to the use case for compounded                Islamic finance were among the types            amount of liquidity in forward
    forward term rates may emerge                                                      simple average.9. In a noteworthy         SONIA in arrears.13. The Sterling             of transactions the Sterling Working            term rates based on overnight RFRs
    from transaction data in OIS and          Loan transactions have been slower       transaction, Royal Dutch Shell            Working Group expressed the view              Group viewed as having a use case for           would necessarily be less than in the
    futures markets after such markets        to use RFRs in arrears. Among the        announced that it had entered into        that the use of SONIA compounded              a term SONIA rate.                              overnight RFRs themselves.14.
    develop sufficient volume and depth       reasons for this seem to be lack of      a syndicated USD 10 billion revolving     in arrears was appropriate and
    (including as to longer maturities).      borrower demand (borrowers like          credit facility where LIBOR will be
                                              being able to set rates in advance, as   replaced by SOFR as early as the first
    Because SONIA has existed since 1997      they can for LIBOR), and that screen     anniversary of closing.10. In addition,
                                                                                                                                    9.
                                                                                                                                      S ee LMA documents here and LSTA documents here and here.
                                                                                                                                    10.
                                                                                                                                          See here.
    and has a relatively mature trading       rates do not yet exist. Additionally,    British American Tobacco announced
                                                                                                                                       British American Tobacco, news release 12 March 2020, British American Tobacco signs £6 billion SONIA and SOFR linked
                                                                                                                                    11 
    market, a compliant SONIA term rate       some lenders do not currently have       that it had executed a new £6 billion           revolving credit facility.
    may exist before such a rate exists for   in place systems to support RFRs,        multi-currency revolving credit              12.
                                                                                                                                        See FSB OSSG, Interest rate benchmark reform – overnight risk-free rates and term rates, 12 July 2018. In this report, the OSSG
    any other LIBOR currency.                 and many borrowers do not have           facility linked to both SOFR and                 emphasized that the use of overnight RFRs by the derivatives markets was important to achieve financial stability. The OSSG
                                              corresponding treasury management        SONIA.11.                                        recognized that in some cases the benefit of fixing the interest rate at the beginning of the period over which interest is paid
    Markets are coming to grips with the      systems. For multicurrency facilities,                                                    using a forward-looking term rate might outweigh the cost savings and other benefits of using an overnight RFR. However,
    possibility that no IOSCO-compliant,      the issue is further complicated                                                          the OSSG expressed the view that the use of such forward-looking term rates would ideally be “more limited” than the current
    RFR-derived forward term rate for         by differences in IBOR transition                                                         use of IBORs, “relatively narrow compared with current use of IBORs” and “largely concentrated in a segment of the cash
    any LIBOR currency may exist at the       between jurisdictions.                                                                    rather than derivative markets” in order to be compatible with global financial stability.
    time that LIBOR is expected to cease      An expectation (once held and now
                                                                                                                                    13.
                                                                                                                                        Sterling Working Group, Use Cases of Benchmark Rates: Compounded in Arrears, Term Rate and Further Alternatives.
                                                                                                                                    14.
                                                                                                                                         See FSB OSSG, Interest rate benchmark reform – overnight risk-free rates and term rates, 12 July 2018.
    at the end of 2021, and are turning       frustrated) that forward term rates

6                                                                                                                                                                                                                                                                          7
Multiple-rate                                                                                                                    Development of market
    jurisdictions                                                                                                                    conventions and information
    With respect to euro and Yen, local authorities have not determined that                                                         During 2020, several developments are expected that may spur
    a transition solely to RFRs is necessary,                                                                                        market activity.

    and have gone forward with a               While the non-LIBOR IBORs in the            In the jurisdictions that have adopted    Market conventions for RFRs                    for new interdealer cross-currency             Bloomberg is expected to publish
    multiple rate approach under which         multiple-rate jurisdictions may             multiple-rate approaches, there is        calculated in arrears (whether                 basis swaps that use SOFR and                  indicative adjusted RFRs, spread
    non-LIBOR IBORs for such currencies,       provide viable forward term rate            some expectation that, in the long        compounded or simple average)                  overnight RFRs in certain other                adjustments and “all-in” fallback rates
    EURIBOR, TIBOR and Euroyen TIBOR           options, local regulators will continue     run, an RFR-derived term rate may         continue to develop, particularly in           jurisdictions.18. The conventions focus        (the combination of the adjusted RFR
    (in each case, reformed to meet new        to examine them to see whether              prove to be more robust than a            the loan markets; to date, the lack            on interdealer transactions and are            and the spread adjustment) for each
    benchmark criteria) exist as forward       such rates (even as they have been          legacy reformed IBOR. However, this       of established conventions has likely          for market participants’ voluntary             relevant IBOR tenor at some point
    term rates alongside the RFRs (and are     reformed) continue to be rooted in          will depend on the development of         contributed to the relative lack of            use. Conventions for both RFR-RFR              during the first half of 2020.
    intended to exist alongside any RFR-       a sufficient volume of transactions         such RFR-derived rates. Additional        syndicated facility agreements that            cross-currency swaps and RFR-IBOR
    derived term rate that may emerge)         in active, liquid underlying markets        challenges may also arise for             refer to such rates (although there            cross-currency swaps are covered. In           The Federal Reserve Bank of New York
    for such currencies. Several non-          to reflect underlying financial             participants in those jurisdictions due   are some bilateral facilities16.). To the      addition, there are potential fallbacks        recently began publishing: (i) three
    LIBOR jurisdictions have taken similar     reality and qualify under the IOSCO         to potentially different types of bases   extent that the markets coalesce               for cross-currency swaps currently             compounded averages of SOFR with
    approaches. The attached matrix            benchmark principles.                       for cross-currency swap transactions.     around standard conventions, activity          referencing IBORs, to cover one or             tenors of 30, 90 and 180 days; and
    considers several of them, including                                                                                             may increase.                                  both counterparties in an IBOR-based           (ii) a daily SOFR index to support the
    Australia, Canada and Hong Kong.                                                                                                                                                swap transitioning from an IBOR to             calculation of compounded average
                                                                                                                                     There remain differences of opinion            an RFR.                                        rates over custom time periods.19. The
                                                                                                                                     over how best to calculate rates                                                              Bank of England recently announced
                                                                                                                                     in arrears, whether to use simple              In addition, new rate and pricing              its intention to publish a SONIA-
                                                                                                                                     average or compounding, and                    information is expected to become              linked index beginning in July 2020.20.
        In its response to a consultation, JBA TIBOR Administration, the administrator of TIBOR and Euroyen TIBOR, stated that
      15.                                                                                                                            whether to use a lag period or an              publicly available, which should               The publication of these averages
         it was likely that Euroyen TIBOR would be discontinued (and that TIBOR would be retained). JBA TIBOR Administration,        observation shift.17.                          provide accessible, consistent                 and indices should provide important
         Result of public consultation: 1st Consultative Document / Approach for Integrating Japanese Yen TIBOR and Euroyen                                                         pricing indices and thereby promote            pricing information and reference
         TIBOR 30 May 2019                                                                                                           In January 2020, the US Alternative            transition. ISDA and Bloomberg are             points to the market.
                                                                                                                                     Reference Rates Committee (ARRC)               expected to finalize methodologies
                                                                                                                                     released final recommendations                 for swap fallback rates, and

                                                                                                                                       16.
                                                                                                                                          See, e.g., Reuters, “Sonia benchmark makes loan market debut,” 8 July 2019.
                                                                                                                                         See, e.g., Sterling Working Group, Statement on bond market conventions: Use of the SONIA Index and weighting approaches for
                                                                                                                                       17.

                                                                                                                                         observation periods.
                                                                                                                                       18.
                                                                                                                                           ARRC, Recommendations for Interdealer Cross-Currency Swap Market Conventions.
                                                                                                                                          Federal Reserve Bank of New York, Statement Regarding Publication of SOFR Averages and a SOFR Index 12 February 2020;
                                                                                                                                       19.

                                                                                                                                          Statement Introducing the SOFR Averages and Index 2 March 2020.
                                                                                                                                       20.
                                                                                                                                           Turbo-charging sterling LIBOR transition: why 2020 is the year for action – and what the Bank of England is doing to help, Speech
                                                                                                                                            given by Andrew Hauser, Executive Director, Markets, Bank of England, at International Swaps and Derivatives Association/SIFMA
                                                                                                                                            Asset Management Group Benchmark Strategies Forum, 26 February 2020. Relatedly, the Bank of England (BofE) also published a
                                                                                                                                            discussion paper seeking views from market participants on: (i) the BofE’s intention to publish a daily SONIA compounded index;
                                                                                                                                            and (ii) the usefulness of the BofE publishing a simple set of compounded SONIA period averages, which would give users easy
                                                                                                                                            access to SONIA interest rates compounded over a range of set time periods. Responses to the questions are due by 9 April 2020.
                                                                                                                                            BofE, Supporting Risk-Free Rate transition through the provision of compounded SONIA February 2020.

8                                                                                                                                                                                                                                                                               9
Legacy
     agreements
     Perhaps the biggest remaining issue is the conversion of legacy LIBOR
     instruments to alternative rates.

     Researchers at the Bank of               2006 ISDA Definitions and entered        emerge there, and issuers will need to    However, there is no avoiding the            effecting LIBOR transition, but should        Parties could opt out of the statute
     International Settlements (BIS)          into before that date. ISDA also         instead refinance current LIBOR FRNs      need for each and every affected             rather focus their efforts on using           by contract. Although the Sterling
     estimated that, as of mid-2018, there    proposes to publish the ISDA 2020        with SOFR FRNs. Despite FRNs often        loan agreement to be amended                 RFRs instead of LIBOR.                        Working Group has established a
     was about USD 400 trillion worth of      IBOR Fallbacks Protocol (Protocol), a    having relatively short maturities,       individually. The Bank of England                                                          “tough legacy” sub-committee to
     financial contracts that referred to     multilateral protocol that will enable   there seem to be some legacy FRNs         and FCA have also recently endorsed          The ARRC recently released a proposal         address contracts that are unable to
     LIBOR.21. At a roundtable convened       parties to derivatives transactions      outstanding that mature after 2021        a target of Q1 2021 for lenders to           for legislation under New York law            convert away from Sterling LIBOR
     by the FSB in July 2019, private         to agree that the new IBOR triggers      and have fallback provisions that         “significantly reduce the stock of           that would address LIBOR transition.27.       by market solutions, the FCA has
     sector representatives stated that       and fallback provisions as set out in    revert to a fixed rate (the last quoted   LIBOR referencing contracts.”26.             This proposal would apply chiefly             been clear that the market should
     dealing with legacy positions was        the revised 2006 ISDA Definitions will   LIBOR rate), rather than having a                                                      to situations where a fallback from           transition and not rely on a possible
     more problematic than writing new        apply to legacy transactions between     more robust fallback.24.                  Regulators have cautioned that               LIBOR did not exist in a contract,            legislative fix.28.
     business referring to RFRs. As noted     Protocol adherents that incorporate                                                market participants should not view          or fell back to a LIBOR-based rate
     above, market receptivity to LIBOR       the 2006 ISDA Definitions, the           In the loan markets, there has            fallbacks as the primary means of            (such as the last quoted LIBOR).
     alternatives varies by market.           2000 ISDA Definitions or the 1991        been some success in inserting
                                              ISDA Definitions, and in existing        robust LIBOR fallback provisions. In
     ISDA proposes to publish a substantial   ISDA Master Agreements and ISDA          most cases, these would trigger a
                                                                                                                                    21..
                                                                                                                                          Beyond LIBOR: a primer on the new benchmark rates, BIS Quarterly Review, March 2019.
     revision to the 2006 ISDA Definitions    collateral support documentation,        negotiation for an amendment that               We note that the ARRC Market Structures Working Group has identified nine possible models of conversion that market
                                                                                                                                    22.

                                                                                                                                       participants may use when voluntarily transitioning derivatives transactions that reference IBORs to RFRs. See Letter to J.
     by way of a Supplement that              as well as certain non-ISDA              could be passed without a 100%
                                                                                                                                       Christopher Giancarlo, chair of US CFTC, Re: Follow-up Letter Regarding Treatment of Derivatives Contracts Referencing the
     contains fallback provisions applying    documentation, that refer to a           lender vote.                                    Alternative Risk-Free Rates, 13 May 2019.
     the applicable term-adjusted RFR plus    relevant IBOR.22.                                                                     23.
                                                                                                                                        Sterling Working Group, Progress on the Transition of LIBOR Referencing Legacy Bonds to SONIA By Way Of Consent Solicitation
     a spread in the event of a permanent                                              The LMA has published an exposure            24.
                                                                                                                                         ICMA, The transition to risk-free rates in the bond market, ICMA Quarterly Report, first quarter 2020.
     cessation of 11 key IBORs: LIBOR         In the Sterling FRN markets, to date,    draft of a reference rate selection          25.
                                                                                                                                         Available here.
     (for each LIBOR currency), EURIBOR,      eight consent solicitations with a       agreement25. with the aim to                 26.
                                                                                                                                         See here
     TIBOR, Euroyen TIBOR, BBSW,              total nominal value of GBP 4.2 billion   streamline the amendment process                ARRC, Proposed Legislative Solution to Minimize Legal Uncertainty and Adverse Economic Impact Associated with LIBOR
                                                                                                                                    27.

     CDOR and HIBOR. These revised            have been announced publicly as          for legacy syndicated loans by                  Transition. We note that Jerome Powell, the chair of the US Fed, has expressed the view that a US federal legislative solution
     definitions will apply by their terms    successful in transitioning English      allowing the required lenders (and              was not necessary at the present time. Law 360, Fed Chair Throws Cold Water On Libor Legislation Idea, 11 February 2020.
     to transactions referring to the 2006    law legacy bond contracts from           borrowers) to agree to the key
                                                                                                                                    28.
                                                                                                                                         See, e.g., LIBOR: Preparing for the end, speech by Andrew Bailey, Chief Executive of the FCA, at the SIFMA LIBOR Transition
                                                                                                                                          Briefing, 15 July 2019: “Market participants will also ask whether legislation could help. For example, could legislators
     ISDA Definitions that are entered        LIBOR to SONIA in arrears.23. Because    amendment terms, but delegating
                                                                                                                                          redefine LIBOR as RFRs plus fixed spreads for those tough legacy contracts? Or could they create safe harbours for those
     into on or after the date on which       US FRNs invariably require a 100%        agreement of the technical details to              adopting consensus industry solutions which enjoy authorities’ support such as compounded RFRs and fixed spreads? These
     the revisions become effective, but      vote to change interest rates, it is     the facility agent (and borrowers).                measures are not in the gift of regulators, but it is sensible to consider their pros and cons.
     not to transactions incorporating the    unlikely that a similar trend will

10                                                                                                                                                                                                                                                                      11
Derivatives
     Fallback rates based on RFRs have been identified for the relevant IBORs
     by ISDA industry working groups. The transition to RFRs is happening
     across all major currencies, although the process and amount of progress
     varies by jurisdiction.29.

                                                                                                                                in” fallback rate (i.e., the compounded   The largest central counterparties       apply in the event that LIBOR is
     ISDA has already published              Significant progress has been made        New interest rate derivatives
                                                                                                                                setting in arrears rate plus the          (CCPs) have indicated they will adopt    declared unrepresentative, following
     Supplements to the 2006 ISDA            by ISDA to prepare the derivatives        transactions entered into after the
                                                                                                                                spread) in the first half of 2020. The    the amended definitions and thereby      some clarification from the FCA
     Definitions including definitions       markets for the adoption of RFRs in       “big bang” date will incorporate the
                                                                                                                                publication of these rates will provide   achieve an equivalent outcome as         and IBA that the publication of a
     for new risk-free rates (such as        place of IBORs, but issues remain.        amended 2006 ISDA Definitions.
                                                                                                                                market participants with more clarity     under the new Protocol for their         non-representative LIBOR would
     compounded SOFR and €STR). Of           Market consensus is still to be           If they wish to ensure that both
                                                                                                                                on the calculation of the spread          legacy cleared portfolios.               be limited in duration.35. A pre-
     particular note is the FCA and the      achieved with respect to pre-             new and legacy IBOR contracts
                                                                                                                                and term adjustments to the RFRs                                                   cessation trigger is included in
     Bank of England statement published     cessation fallbacks. There are also       reference the same fallbacks, market
                                                                                                                                that would apply to fallback rates,       For market participants using interest   many fallback provisions for cash
     in January 2020 encouraging the         issues relating to basis risk for LIBOR   participants will need to transition
                                                                                                                                increasing market acceptance and          rate derivatives as a hedging tool,      products. However, an earlier ISDA
     change of the market convention         referenced derivatives linked to, or      their legacy trades by adherence to
                                                                                                                                liquidity. Accordingly, the publication   a particularly salient issue is the      consultation36. did not yield market
     for Sterling interest rate swaps from   hedging a floating rate loan or other     the new Protocol.
                                                                                                                                of adjusted RFR fallback rates are        potential basis risk between the         consensus on how to implement
     Sterling LIBOR to SONIA on 2 March      debt instrument. Other challenges
                                                                                                                                expected to be a significant catalyst     derivative and the underlying cash       pre-cessation fallbacks in derivatives
     2020.30. This is intended to shift      include, for example, market              However, market acceptance of the
                                                                                                                                for market participants to effect         product it hedges, should the agreed     contracts. The new consultation is
     new trading in Sterling interest rate   adoption of RFRs (the “chicken-           transition of legacy contracts to the
                                                                                                                                transition in earnest.                    fallbacks in the derivatives markets     open until 1 April 2020.
     swaps to SONIA and limit risks from     and-egg” problem), liquidity of           new fallbacks will depend on the
                                                                                                                                                                          differ from those adopted in the
     new LIBOR exposures. In addition,       RFR-referenced markets, legal issues      market having more visibility of the
                                                                                                                                There could be possible distortion        market for the underlying product.       This new ISDA consultation will ask
     a top priority identified by the        relating to contract amendments,          calculations of the adjustments to the
                                                                                                                                in the cross-currency markets if          The current ISDA proposals include       whether the 2006 ISDA Definitions
     Sterling Working Group is that new      issues relating to valuation and risk     RFRs and clarity on the regulatory,
                                                                                                                                the transition to the various RFRs        template documentation to exclude        should be amended to include
     issuances of Sterling LIBOR-based       management as well as accounting          accounting and tax implications
                                                                                                                                occurred at different times. It           transactions from the scope of the       fallbacks that would apply on
     cash products maturing beyond 2021      and tax treatment.32.                     of the transition. In order to value
                                                                                                                                has been noted that “substantial          Protocol at the option of the parties,   the first to occur of a permanent
     cease by the end of the third quarter                                             portfolios and make decisions
                                                                                                                                risks could stem from low market          thereby affording the parties the        cessation of an IBOR or on a pre-
     of 2020.31. As market participants      The proposed Supplement to the            as to the timing of transition of
                                                                                                                                awareness and acceptance of the           ability to agree to bespoke fallback     cessation event. If there is not
     start issuing more cash products that   2006 ISDA Definitions for new             existing legacy IBOR transactions
                                                                                                                                [RFR] benchmarks. In particular,          provisions so that the fallback for an   sufficient support for this approach,
     reference SONIA, SOFR and other         transactions and the Protocol             to RFRs, market participants require
                                                                                                                                benchmark reforms in major currency       excluded derivative should match         ISDA proposes to amend the 2006
     RFRs, it is expected that this will     for existing transactions will be         information that is not currently
                                                                                                                                areas could affect regional markets       that in the related hedged product.      ISDA Definitions to enable derivatives
     increase market demand for RFR-         effective on a “big bang” date to be      available. The efficiency of interest
                                                                                                                                through the use of cross-currency                                                  counterparties to incorporate
     based derivative hedging products.      announced. This is currently expected     rate risk management is also affected
                                                                                                                                basis or foreign exchange swap            ISDA recently launched a public          pre-cessation fallbacks alongside
     As the transition away from LIBOR       to be approximately three to four         by the lack of liquidity in RFRs.
                                                                                                                                related products in certain market        consultation regarding whether to        permanent cessation fallbacks if they
     progresses, the focus will move         months after the Supplement and           Bloomberg Index Services Limited is
                                                                                                                                segments, thereby posing potential        include a pre-cessation trigger in       choose to.
     towards the practical implementation    Protocol have been published by           expected to produce and publish the
                                                                                                                                risks to market functioning.”33.          the ISDA fallbacks,34. which would
     of new RFR products.                    ISDA, which is currently expected to      compounded setting in arrears rate,
                                             be in the third quarter of 2020.          the spread adjustment and the “all-

12                                                                                                                                                                                                                                                          13
Enhanced
                                                                                                                                    scrutiny
     The timing of publication of the                                                                                               Many regulatory bodies have
                                                   New consultation on combination of         25 February 2020                                                                  S ee, e.g., the FSB (supra n. 1); the US Office of the Comptroller of the Currency,
                                                                                                                                                                              37.
     Supplement to the 2006 ISDA                                                                                                    indicated that they will actively
                                                   permanent cessation fallbacks and pre-                                                                                        Semi-Annual Risk Assessment, December 2019 §§3.3, 6.3; the US Financial Stability
     Definitions and the Protocol will now         cessation fallbacks                                                              monitor LIBOR transition at regulated
                                                                                                                                                                                 Oversight Council, 2019 Annual Report; the FCA, Conduct risk during LIBOR
     be subject to the results of the new                                                                                           institutions in 2020 and will urge such      transition and “Dear CEO” letter to asset management firms 27 February 2020;
     consultation. The proposed timing             Deadline for consultation responses        25 March 2020                         institutions to accelerate matters.37.       and FINMA, FINMA Risk Monitor 2019.
     of the consultation, publication
     of results and publication of the             Publication of consultation results        Late April 2020-Early May 2020
     Supplement to the 2006 ISDA                   and announcement of next steps for
                                                   implementing permanent cessation and
     Definitions and the Protocol are set
                                                   pre-cessation fallbacks
     out opposite.
                                                   Publication of Bloomberg indicative        First half of 2020
                                                   fallback rates

                                                   Publication of final form of Supplement    Targeting Q3 2020
                                                   to the 2006 ISDA Definitions and of
                                                   ISDA 2020 IBOR Fallbacks Protocol

                                                   Effectiveness of Supplement to the         3-4 months after publication
                                                   2006 ISDA Definitions and of ISDA 2020
                                                   IBOR Fallbacks Protocol

        29.
             ISDA Research Note, Adoption of Risk-Free Rates: Major Developments in 2020 February 2020.
        30.
             FCA and Bank of England encourage switch from LIBOR to SONIA for sterling interest rate swaps from Spring 2020,
             available at: https://www.fca.org.uk/news/statements/fca-and-bank-england-encourage-switch-libor-sonia-sterling-
             interest-rate-swaps-spring-2020.
           Sterling Working Group 2020 Top Level Priorities.
        31.

        32.
            See, e.g., Study on the Implications of Financial Benchmark Reforms EMEAP Working Group on Financial Markets
            September 2019.
        33.
            Study on the Implications of Financial Benchmark Reforms EMEAP Working Group on Financial Markets September 2019.
        34.
            ISDA, 2020 Pre-Cessation Fallback Consultation.
        35.
           See ISDA 4 December 2019 letter to FSB OSSG re: ISDA Pre-Cessation Triggers for Derivatives Fallbacks; November 2019
            letter from the OSSG to ISDA regarding pre-cessation triggers; January 2020 letter from FCA to ISDA; and January 2020
            letter from the IBA to ISDA.
        36.
             See here.

14                                                                                                                                                                                                                                                                     15
Conduct and
     litigation risk
     When transitioning from LIBOR, product governance and conduct
     obligations must be met.

     In the UK, at a high level, this          provisions that replace LIBOR              and, of course, as regards professional         Where firms do offer LIBOR-linked          interest rate derivatives to hedge            Regulators have also warned
     manifests itself in the regulatory        are expected to work. As with all          investors. To fulfill this duty client facing   products maturing after 2021, they         interest rate risk and that invest in         regulated institutions of the litigation
     obligation on authorized firms            communications, those around               staff must have adequate knowledge              should take care to see customer           bonds or other securities which refer         risk that may be inherent in LIBOR
     to treat customers fairly and             LIBOR transition should be clear, fair     and receive appropriate training.               needs are met and products will            to LIBOR, steps should be taken to            transition.39. This risk may arise
     analogous provisions may apply            and not misleading. Additionally,                                                          continue to perform as expected            assess client exposures and plan the          particularly from value transfer and
     to other jurisdictions. The FCA has       they should be timely, allowing            As a corollary, firms should consider           (despite the uncertainty over how          transition with the best interests            from dealings with retail customers,
     published information to help firms       customers sufficient opportunity           whether variations of contracts to              rates will be calculated in the            of customers to the fore. This may            and may be especially pronounced in
     in this respect while setting out         to make informed decisions. Firms          introduce fallbacks or alternative              future). The regulatory preference         include revising investment strategy          the US.
     their regulatory expectations.38.         should describe the risks and impacts,     rates are fair and lawful. This issue is        nonetheless is to avoid such               and best execution policies.
     The consequences of this duty vary        including the benefits and costs of        particularly acute where retail clients         contracts. For firms, such as asset
     depending on whether customers are        alternative products. It goes without      are concerned. The FCA suggests                 managers, that use LIBOR-referencing
     market counterparties, professional       saying that communications should          that firms that can show that a
     clients and retail investors — the last   not “disguise, reduce or hide” relevant    replacement rate represents the
     receiving the greatest protection.        information. It is essential to consider   market consensus, possibly agreed
                                               the knowledge and experience of the        though industry working groups and                     See FCA webpage on conduct risk during LIBOR transition at https://www.fca.org.uk/markets/libor/conduct-risk-during-
                                                                                                                                              38.

     A key aspect of treating customers        intended audience — retail mortgage        after consultation, are more likely                    libor-transition.
     fairly is effective communication,        borrowers will have a lower level of       to be acceptable. ISDA’s work on                       See, e.g., Remarks by Michael Held, Executive Vice President of the Legal Group of the Federal Reserve Bank of New York,
                                                                                                                                              39.

     for example, explaining how fallback      knowledge compared to corporates           fallback rates is cited as an example                  at the SIFMA C&L Society February Luncheon, New York City, 26 February 2019: “You can imagine the litigation risk when
                                                                                          in this regard.                                        the reference rate for a 20-year contract disappears and there’s no clear path to replace it. Now imagine 190 trillion
                                                                                                                                                 dollars’ worth of those contracts. This is a DEFCON 1 litigation event if I’ve ever seen one.”

16                                                                                                                                                                                                                                                                            17
Key upcoming developments
     and potential developments
     2020 will be a critically important year for LIBOR transition.

     There are many separate workstreams       the Supplement to the 2006 ISDA            to transition discounting and PAI for     The ARRC has also commenced a              and is expected to publish summary           purposes or could result in other
     currently involved in LIBOR transition,   Definitions and related Protocol           cleared euro products from EONIA          consultation on spread adjustment          results during Q2 2020. Responses            tax consequences.46. The comment
     and these are scheduled to produce        will act as a catalyst for market          to €STR on or about 22 June 2020.         methodologies for fallbacks in cash        were due by 6 February 2020.                 period for the proposed regulations
     a number of items during the year         participants to transition legacy          These changes are expected to drive       products referencing USD LIBOR.44.                                                      has ended, and the regulations are
     that should clarify matters by            LIBOR portfolios. The expected             liquidity in €STR and SOFR products.40.   Responses are due by 25 March 2020.        In October 2019, the US Treasury             expected to be finalized at some
     reducing uncertainty, removing            publication by Bloomberg of indicative     These changes will also result in         This rate would be the first step          department issued proposed tax               point in 2020.
     legal, regulatory or tax obstacles and    fallback rates and spread adjustments      valuation changes for affected            in the ARRC hardwired approach             regulations intended to address
     providing additional and improved         in the first half of 2020 should provide   transactions that the CCPs propose        waterfall for a spread adjustment.         the possibility that an alteration of
     pricing information concerning RFRs       clarity to market participants to assist   to address through compensation           Also with respect to spread                the terms of a debt instrument or a
     and how they behave.                      in this transition.                        mechanisms.41. In February 2020, the      adjustments, the Sterling Working          modification of the terms of other
                                                                                          ARRC also issued a consultation on        Group has an ongoing consultation          types of contracts to replace an IBOR
     Many regulators and working               Importantly, several major CCPs have       swaptions based on USD LIBOR that         on credit adjustment spread                with a new reference rate could result
     groups, including the FSB, the ARRC       announced plans to shift discounting       could be affected by the discounting      methodologies for fallbacks in cash        in the realization of income or other
     and the Sterling Working Group,           and price alignment interest (PAI) for     change for cleared derivatives            products referencing GBP LIBOR,45.         tax items for US federal income tax
     have committed to make efforts to         cleared USD and euro derivatives to        from the use of EFFR to SOFR.42. The
     increase the awareness of end users       RFRs. On 16 October 2020, LCH and          working group on euro risk-free rates
     in the cash markets of the need to        CME have stated that they will: (i)        recently launched a consultation on         40.
                                                                                                                                            ISDA Research Note, Adoption of Risk-Free Rates: Major Developments in 2020 February 2020.
     engage in LIBOR transition, to build      use SOFR (instead of the Effective         the impact of the transition from
                                                                                                                                      41.
                                                                                                                                         ISDA Research Note, Adoption of Risk-Free Rates: Major Developments in 2020 February 2020.
     demand and trading volumes in RFR         Federal Funds Rate (EFFR)) for PAI         EONIA to €STR transition on the
                                                                                                                                      42.
                                                                                                                                          ARRC Consultation on Swaptions Impacted by the CCP Discounting Transition to SOFR.
     products and to reduce the stock          and discounting of new USD swap            swaptions market.43.                           euro Working Group, Public consultation on Swaptions impacted by the CCP discounting transition from EONIA to the €STR;
                                                                                                                                      43.

                                                                                                                                         the response date is 3 April 2020.
     of legacy transactions that refer to      contracts going forward; and (ii)                                                      44.
                                                                                                                                           ARRC Consultation on Spread Adjustment Methodologies for Fallbacks in Cash Products Referencing USD LIBOR; the response
     LIBOR in advance of LIBOR’s expected      modify outstanding USD swap                                                                  date (originally 6 March 2020) was extended to 25 March 2020.
     demise at the end of 2021.                contracts to replace EFFR with SOFR                                                    45.
                                                                                                                                         Consultation on credit adjustment spread methodologies for fallbacks in cash products referencing GBP LIBOR.
     As noted above, it is expected that       for PAI and discounting. Further,                                                      46.
                                                                                                                                         The proposed regulations are available here.
     the publication and effectiveness of      LCH, Eurex and CME are scheduled

18                                                                                                                                                                                                                                                                    19
Remaining
     Challenges
     Despite all the work done to date on LIBOR transition, a vast amount of
     work remains to be done.

     The FCA and other regulators              Because time is growing shorter,         resources and attention of regulators    The FCA, the BofE and the Sterling           Further, it would be a systemic          There may be a difference in whether
     appear firm in holding to the end-        parties no longer have the option        and market participants from many        Working Group indicated that                 nightmare if the many agreements         a pre-cessation trigger is included
     2021 deadline. Further, it is widely      of kicking the can down the road.        other projects, not limited to LIBOR     they would continue to monitor               that have included an “amendment         in fallbacks for derivatives and cash
     thought that the current LIBOR            Parties to contracts that refer to       transition. In many respects, the        the situation.                               approach” fallback all needed to         products. Further, LIBOR might be
     panel banks want to stop making           LIBOR must now change those              timeline for transition was extremely                                                 be amended at the same time.             declared unrepresentative earlier
     LIBOR submissions as soon as              contracts or replace them, using         ambitious when set, and the many         Contractual fallbacks continue               Finally, market participants will need   than 2021 (which might trigger
     possible, and will likely stop doing      those alternatives that have been        issues posed by Covid-19 may make it     to be developed, although the                to consider whether fallbacks in         some fallback clauses, but not
     so when their agreement ceases            developed. Despite the many              more difficult for markets to achieve    regulators have been clear that              different currencies and asset classes   others), and this declaration might
     at the end of 2021 (unless they are       warnings from the official sector and    the remaining goals of that timeline     fallbacks (however robust) should            are aligned.                             be made only with respect to some
     compelled otherwise).                     others, awareness of the issue among     by the original target dates.47. On 25   not be viewed as the most effective                                                   LIBOR currencies, but not all of
                                               corporate entities seems to be           March 2020, the FCA, the BofE and        or primary means of handling the             Developments in LIBOR transition         them. Depending on their LIBOR
     There has perhaps been some inertia       mixed. The scale of the operational      the Sterling Working Group issued a      transition, and that parties should          have been uneven among                   exposures, firms may need to create
     in the market to date as parties have     challenge cannot be understated:         statement on the impact of Covid-19      instead use alternative interest             currencies and products, and market      decision trees that consider many
     waited for further clarification or       any single bank or other financial       on firms’ LIBOR transition plans.48.     rates so that reliance on fallbacks          participants need to consider that       possible variations of an already
     for better alternatives to emerge.        institution may have an enormous         The statement said that “[t]he           is not necessary. Although fallback          there may well be considerable           complex theme.
     However, to the extent the situation      number of these contracts.               central assumption that firms cannot     provisions may improve as rate               disparity among currencies and
     has been clarified, the alternatives                                               rely on LIBOR being published after      options and spread adjustments               products at the end of 2021. ~
     that have emerged may not be              Several of the transition target dates   the end of 2021 has not changed and      develop, reliance on fallbacks               For example, as noted above, a SONIA
     perfect or what some had once             that have been set by the regulators     should remain the target date for        may involve an increased risk of             term rate may exist sooner than a
     hoped for. In particular, users of cash   and working groups may be hard to        all firms to meet.” They conceded        value transfer.                              SOFR term rate.
     products that are used to LIBOR are       achieve at this point. As a further      that there had been an impact on
     likely to need to switch to backward-     complication, the effect that the        the timing of some aspects of the
     looking benchmark rates calculated        Covid-19 pandemic will have on LIBOR     transition programs of many firms,
     in arrears.                               transition has yet to be determined.     and indicated that some of the                See Risk.net, Pandemic threatens Libor transition plans, 13 March 2020.
                                                                                                                                    47.
                                               At a minimum, Covid-19 appears           interim transition milestones might           Available here.
                                                                                                                                    48.

                                               to be significantly diverting the        be affected.

20                                                                                                                                                                                                                                                             21
IBOR Transition
     Readiness Matrix
     This matrix ranks LIBOR (and select         A “5” grade indicates that substantial   that significant developments need to
     other IBOR) jurisdictions and products     certainty exists and that there are no    occur in order to achieve readiness.49.
     according to the level of readiness for    or very few additional steps that need
     LIBOR transition, on a scale of 1 to 5,    to be taken; a “1” grade indicates that   Grade Key:
     with 1 indicating the least ready, and 5   substantial uncertainty exists, and
     indicating the most ready.                                                            1              2   3           4          5

      IBOR Jurisdiction                  UK/Sterling           US/USD                 Euro zone/euro          Japan/Yen                  IBOR Jurisdiction                 Switzerland/   Australia/A$/    Canada/C$/      Hong Kong/      Singapore/S$/
                                         /SONIA                /SOFR                  /€STR                   /TONA                                                        CHF/SARON      AONIA            CORRA           HK$/HONIA       SORA
      Click the flag for                                                                                                                 Click the flag for
      more information —-›                                                                                                               more information —-›

      Derivatives -in overnight RFRs*             5                      4                     3                       3                 Derivatives -in overnight RFRs*          3              4               4               2                    2

      Derivatives -in forward                                                                  5                       5                 Derivatives -in forward                                 5               5               5                    1
      term rates **50.                                                                      EURIBOR            TIBOR/Euroyen TIBOR       term rates ** 50.                                     BBSW             CDOR           HIBOR           54.
                                                                                                                                                                                                                                                     SIBOR
                                                  4                     2                                                                                                         1
                                                                                                1                       1                                                                         1               1               1                   1
                                                                                           RFR-derived             RFR-derived                                                               RFR-derived     RFR-derived     RFR-derived      RFR-derived

      Derivatives- fallbacks                      3                      3                     3    53.                3                 Derivatives- fallbacks                   3              3               3               2                    1

      FRNs -in overnight RFRs,                                                                                                           FRNs -in overnight RFRs,
                                                  5                      5                     2                       2                                                          3              3
      compounded in arrears*                                                                                                             compounded in arrears*

      FRNs – in forward term rates**                                                           5                       5                 FRNs – in forward term rates**                          5               5               5                    1
                                                                                            EURIBOR            TIBOR/Euroyen TIBOR                                                             BBSW             CDOR           HIBOR            SIBOR
                                                  2                      1                                                                                                        1
                                                                                                1                       1                                                                         1               1               1                   1
                                                                                           RFR-derived             RFR-derived                                                               RFR-derived     RFR-derived     RFR-derived      RFR-derived

      FRNs- fallbacks                             3                      3                     3                       2                 FRNs- fallbacks                          3              3               4                                    1

      Loans-in overnight RFRs *51.                3                     2                      2                       2                 Loans-in overnight RFRs * 51.            2

      Loans -in forward term rates**                                                           5                       5                 Loans -in forward term rates**                          5               5               5                    1
                                                                                            EURIBOR            TIBOR/Euroyen TIBOR                                                             BBSW             CDOR           HIBOR            SIBOR
                                                  2                      1                                                                                                        1
                                                                                                1                       1                                                                         1               1               1                   1
                                                                                           RFR-derived             RFR-derived                                                               RFR-derived     RFR-derived     RFR-derived      RFR-derived

      Loans –fallbacks 52.                                                                     3                       1                 Loans –fallbacks 52.                     3              3               4               1                    1
                                                  5                      5

      Securitizations -                                                                                                                  Securitizations -
                                                  4                      4                                              1                                                         1              3
      in overnight RFRs*                                                                                                                 in overnight RFRs*

      Securitizations- in forward                                                              5                       5                 Securitizations- in forward                             5               5               5                    1
      term rates**                                                                          EURIBOR            TIBOR/Euroyen TIBOR       term rates**                                          BBSW             CDOR           HIBOR            SIBOR
                                                  2                      1                                                                                                        1
                                                                                                1                       1                                                                         1               1               1                   1
                                                                                           RFR-derived             RFR-derived                                                               RFR-derived     RFR-derived     RFR-derived      RFR-derived

      Securitizations – fallbacks                 5                      5                     3                        1                Securitizations – fallbacks              3              3               4                1                   1

22                                                                                                                                                                                                                                                           23
UK/Sterling/SONIA
     *Rankings of overnight RFRs include an assessment of receptivity to transition of legacy IBOR books to compounded RFRs, in arrears.
                                                                                                                                                                    SONIA is the identified RFR for Sterling and has existed since 1997. In
     **Forward term rates refer to rates other than LIBOR. For forward term rates in multiple-rate jurisdictions, two rankings are given: (i) one for              its 2019 progress report, the FSB found that “[t]here has been good
           such jurisdiction’s existing non-LIBOR IBOR; and (ii) one for a forward term rate derived from such jurisdiction’s identified RFR.
     49.
          Among the factors examined are: the degree of liquidity that exists; the degree of consensus achieved regarding market conventions;
                                                                                                                                                                    progress in establishing SONIA as the successor to sterling LIBOR.” The
          whether impediments exist with respect to the development or adoption of a product; and the degree of uncertainty remaining with                          FSB noted increases in Sterling FRNs and securitizations denominated in
          respect to market consensus or legal, regulatory, accounting or tax treatment.
     50.
          We note that derivatives trading in forward term rates based off RFRs does not necessarily involve the use of a rate that is being used as a benchmark.   compounded SONIA, and the development of liquidity in SONIA swaps
     51.
        Some market appetite exists in the US for simple average SOFR in arrears because it may be easier to operationalize a simple average rate
         than a compounded rate with respect to loans, which are relatively easier to prepay than other debt. In addition, a simple average may be
                                                                                                                                                                    and futures.
         easier to use to calculate prices for loan trades with delayed settlement.
     52.
         To date, most fallbacks with respect to loans have adopted an amendment approach, rather than a hardwired approach.
     53.
         This assessment includes not only a contractual fallback from EUR LIBOR, but also a contractual fallback from EURIBOR.
     54.
         As currently constituted, SIBOR is vulnerable to a discontinuation of USD LIBOR, since SIBOR relies on the SGD Swap Offer Rate (SOR), which               In January 2020, the Bank of England           These priorities also include a March           provisional SONIA forward term rate)
          is an FX swap implied interest rate computed from actual transactions in the USD/SGD FX swap market, and which uses USD LIBOR as an                       (BofE), the FCA and the Working                2020 target date to switch from                 is expected by the end of Q3 2020.58.
          input in its waterfall methodology. For this reason, regulators in Singapore determined that SIBOR would not be a suitable alternative to                 Group on Sterling Risk-Free Reference          LIBOR to SONIA for Sterling interest
          SOR in SGD interest rate derivatives. See below.                                                                                                          Rates (Sterling Working Group)                 rate swaps.                                     The BofE has also announced
                                                                                                                                                                    published a set of documents that                                                              that (i) from October 2020, it will
                                                                                                                                                                    outline LIBOR transition priorities and        With respect to a forward term rate             make newly issued LIBOR-linked
                                                                                                                                                                    milestones for 2020.55.                        based on SONIA, “Beta” testing of               collateral ineligible to be lent
                                                                                                                                                                                                                   term rates being developed by FTSE              against as part of the BofE’s Sterling
                                                                                                                                                                    The Sterling Working Group’s                   Russell, ICE Benchmark Administration           Monetary Framework and (ii) it will
                                                                                                                                                                    priorities include a target that the           (IBA), IHS Markit and Refinitiv has             progressively increase the haircuts
                                                                                                                                                                    markets cease issuing cash products            been targeted for February 2020.57.             on existing LIBOR-linked collateral it
                                                                                                                                                                    linked to sterling LIBOR by the end            In addition, the BofE and the FCA               lends against.59. The haircut add-on
                                                                                                                                                                    of the third quarter of 2020, and              have obtained commitments from                  will be 10 percentage points from 1
                                                                                                                                                                    also include considering how best              large liquidity providers to stream             October 2020, 40 percentage points
                                                                                                                                                                    to address issues of “tough legacy”            executable quotes for SONIA OIS for             from 1 June 2021 and 100 percentage
                                                                                                                                                                    contracts (which refers to contracts           1-, 3- and 6-month terms for a testing          points from 31 December 2021. This
                                                                                                                                                                    that cannot transition from LIBOR by           period. Live production of those                development is expected to increase
                                                                                                                                                                    means of market-based solutions).56.           rates (which could be the basis for a           SONIA trading.60.

                                                                                                                                                                         See Sterling Working Group 2020 Top Level Priorities; BofE and FCA, Next steps for LIBOR transition in 2020: the time to act is now
                                                                                                                                                                      55.

                                                                                                                                                                      56.
                                                                                                                                                                          Sterling Working Group, Minutes of 7 November 2019 Meeting.
                                                                                                                                                                         Sterling Working Group, 2020 Top Level Priorities; Sterling Working Group, Progress on adoption of risk-free rates in sterling
                                                                                                                                                                      57.

                                                                                                                                                                         markets 15 May 2019; IHS Markit presentation September 2019.
                                                                                                                                                                      58.
                                                                                                                                                                          Sterling Working Group, Minutes of 7 November 2019 Meeting.
                                                                                                                                                                      59.
                                                                                                                                                                          BofE, The Bank's risk management approach to collateral referencing LIBOR for use in the Sterling Monetary Framework -
                                                                                                                                                                          Market Notice, 26 February 2020.
                                                                                                                                                                      60.
                                                                                                                                                                          See, e.g., BoE's Libor collateral haircut set to accelerate Sonia trading, IFLR Practice Insight, 28 February 2020.

24                                                                                                                                                                                                                                                                                                             25
US/USD/SOFR
     According to IOSCO, “USD LIBOR is by far the most significant and widely
     used benchmark.”61. The US has not adopted a multiple-rate approach and
     has identified SOFR as its RFR. SOFR has been published since the second
     quarter of 2018.

     In its 2019 progress report, the FSB           In October 2017, the US Alternative           The ARRC has stated that it views        In its recent consultation on                 Unfortunately, the sixth and last step,        The ARRC has not retreated from
     found that “[a]lthough USD LIBOR               Reference Rates Committee (ARRC)              the first four steps as having been      swaptions,64. the ARRC noted that,            the development of a term reference            step 6’s target completion date. It
     remains the dominant rate, SOFR cash           set forth its Paced Transition Plan,62.       accomplished on or prior to their        following consultation with their             rate based on SOFR, appears unlikely           has said that it intends to endorse
     markets have begun to grow,” and               which sets out six steps and target           target completion dates, and that the    users, LCH and CME had announced              to occur by its target completion              a forward term rate for SOFR,
     noted significant issuances of SOFR            completion dates for the transition           fifth step will likely be accomplished   plans that would replace steps                date. At the October 2019 meeting of           provided consensus can be reached
     FRNs and securitizations.                      from USD LIBOR. In 2019, the ARRC             at least six months earlier than its     4 and 5 of the original paced                 the ARRC, staff from the US Federal            among its members that a robust,
                                                    issued a set of incremental objectives.63.    target completion date.                  transition plan with a plan to take           Reserve Board made a presentation              IOSCO-compliant term benchmark
                                                                                                                                           the following steps effective at              which noted that, while SOFR futures           that meets appropriate criteria
                                                                                                                                           the close of business on 16 October           volumes have grown significantly               set by the ARRC can be produced.
                                                                                                                                           2020: (i) use SOFR (instead of EFFR)          since the inception of SOFR, current           However, it has cautioned that the
                                                           ARRC Paced Transition Plan
                                                                                                                                           for PAI and discounting of new USD            market depth and trading volumes               production and timing of such a
       Step                                                                                  Original target       Actual completion       swap contracts going forward; and             significantly lag fed funds futures            rate cannot be guaranteed.
                                                                                             completion date       date                    (ii) modify outstanding USD swap              and do not yet appear to be sufficient
                                                                                                                                           contracts to replace EFFR with SOFR           to create a robust IOSCO-compliant
       1. Infrastructure for futures and/or OIS trading in the new rate is put in place      2018 H2               Began in 2018           for PAI and discounting.65.                   SOFR term rate.66.
       by ARRC members.

       2. Trading begins in futures and/or bilateral, uncleared, OIS that reference SOFR.   End of 2018           Began in May 2018

       3. Trading begins in cleared OIS that reference SOFR in the current (EFFR) PAI        2019 Q1               Began in 2018              61.
                                                                                                                                                 IOSCO, Statement on Communication and Outreach to Inform Relevant Stakeholders Regarding Benchmarks Transition 31
       and discounting environment.                                                                                                               July 2019.
                                                                                                                                              62.
                                                                                                                                                   See here.
       4. CCPs begin allowing market participants a choice between clearing new or           2020 Q1               Began in 2018              63.
                                                                                                                                                   See here.
       modified swap contracts (swaps paying floating legs benchmarked to EFFR,                                                               64.
                                                                                                                                                   ARRC, Consultation on Swaptions Impacted by CCP Discounting Transition to SOFR.
       LIBOR, and SOFR) into the current PAI/discounting environment or one that                                                              65.
                                                                                                                                                  See CME, SOFR Discounting & Price Alignment Transition Plan for Cleared USD Interest Rate Swaps and LCH, letter to
       uses SOFR for PAI and discounting.                                                                                                          SwapClear users re: Proposed next steps for transition to USD SOFR discounting in SwapClear, 26 July 2019.
                                                                                                                                              66.
                                                                                                                                                   Minutes of 22 October 2019 meeting of the ARRC. The Federal Reserve Staff stated that volume in SOFR trades was
       5. CCPs no longer accept new swap contracts for clearing with EFFR as                 2021 Q2               CME and LCH have
                                                                                                                                                   concentrated in near-term contracts and that there was a lack of depth in the order book for SOFR futures. The
       PAI and discounting except for the purpose of closing out or reducing                                       announced that
                                                                                                                                                   Federal Reserve Staff also stated that, "[w]ith regard to benchmark robustness, the IOSCO principles embed a sense of
       outstanding risk in legacy contracts that use EFFR as PAI and discount rate.                                they expect to
                                                                                                                                                   proportionality – the more widely a reference rate is used, the more robust it needs to be." The staff said that the limited
       Existing contracts using EFFR as PAI and the discount rate continue to exist in                             move SOFR PAI/
                                                                                                                                                   futures market depth risks SOFR term rates that may be overly volatile or inconsistent with other market term rates
       the same pool, but would roll off over time as they mature or are closed out.                               discounting on
                                                                                                                                                   sensitive to spurious trades and subject to manipulation.
                                                                                                                   both new and
                                                                                                                   legacy swaps on 16
                                                                                                                   October 2020.

       6. Creation of a term reference rate based on SOFR derivatives markets once           End 2021              ?
       liquidity has developed sufficiently to produce a robust rate.

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