Welcome back to our discussion on the LIBOR transition! Debt instruments based on the London Interbank Offered Rate (LIBOR) will be “transitioned” using new benchmarks, called “Risk-Free Rates” (RFR), resulting in healthier financial instruments by the end of 2021. Financial institutions in the U.S. will transfer to SOFR, the U.K. will transfer to SONIA, Switzerland will transfer to SARON, Japan will transfer to TONA, and the E.U. will transfer to ESTER.

If you haven’t already, check out our introduction to the transition, the important players, and why it’s important here.


2019 LIBOR Update

On February 21, 2019, Megan Butler of the Financial Conduct Authority (FCA) provided an overview of the progress around the LIBOR transition. Butler explained that LIBOR is now an outdated concept, because our current market systems have changed so drastically from those within which LIBOR was created to function. Key takeaways from the speech included:

  • Issuance Improvement: Advanced firms are progressing on the adoption of the new RFRs (such as SONIA) in place of LIBOR through efforts by many large bond issuers, such as the European Investment Bank (EIB), when issuing new large floating rate notes. This is quickly becoming common practice.
  • Firms Feedback: In September 2018, the FCA wrote a joint letter of notice with the Prudential Regulation Authority (PRA) to the CEOs of major banks and insurers in the U.K. requesting that they quantify their LIBOR exposure and detail how they will manage identified risks. Since reviewing these responses, the FCA can state that many firms showed substantive progress in preparing for the transition. This letter also served as a catalyst for several firms to start identifying senior managers responsible for implementing transition programs.
  • Buy-side: In response to learning that the buy-side (debt instrument purchasers) is transitioning much more slowly than the sell-side (debt instrument issuers), the FCA spoke directly to two issues raised by firms participating in derivatives markets:
    • First, firms want to wait for liquidity to develop. In response, the FCA stated that new numbers show there is currently liquidity available in new key markets, meaning firms can benefit right now from liquid markets in LIBOR rates.
    • Secondly, firms claim that dealing costs are a deterrent to transitioning. Dealing costs are expenses incurred by buyer and/or seller during a transaction involving derivatives. These expenses mostly come from the due diligence stage of a transaction, which requires legal costs, appraisal costs, and tax costs. In response, the FCA suggested that firms wary of these costs could choose to unwind LIBOR derivatives and replace them with RFR derivatives as part of their day-to-day adjustment of hedges or positions. This may decrease dealing costs, because the FCA’s suggestion to “unwind” LIBOR derivatives and “put on” RFR derivatives in their place could be done in small amounts each day.

Butler concluded by stating that the biggest obstacle to a smooth transition is inertia and encouraged all firms to begin their transitions now.

Read the full speech here.


Steps for Managing Your Transition from LIBOR to SOFR

Any firms currently holding debt instruments based on LIBOR must take part in the transition. Firms must invest resources in the following transition activities:

  1. Inventory of all LIBOR-affected products and documentation
  2. Changing governance structures
  3. Performing impact assessments
  4. Remediating legacy contracts referencing LIBOR
    • ISDA master agreements must be replaced/amended
    • Original documentation for retail mortgages and consumer/business debt tied to LIBOR must be amended
    • Mortgage-Backed Securities, loans, and floating rate bonds will need to be addressed with contracts
  5. Negotiating with clients
    • Reaching consensus with all parties that shifting from LIBOR to RFR (i.e., SOFR) is fair and reflective of the original interest rate and risk in LIBOR
  6. Negotiating with regulators
  1. Managing increased regulatory obligations for risk management and consumer disclosure (if a financial institution continues to issue securities and contracts that mature post-2021 which reference LIBOR)

If you require support with your LIBOR transition, 8of9 can help! Reach out to Christine.Min@8of9.nyc with any questions.