Libor’s End Forces Global Banks to Juggle Multiple Replacements

(Bloomberg) -- For the world’s biggest financial firms, getting ready for the end of one multi trillion-dollar global reference rate is a monumental undertaking. Getting ready for the end of half-a-dozen? Some would call that impossible.

Yet that’s what many market participants are facing as Libor’s demise approaches. The decision to phase out the scandal-tainted set of benchmarks by the end of 2021 is forcing regulators around the world to simultaneously push ahead with their own domestic funding-rate alternatives.

For global firms with hundreds of billions of dollars of exposure to Libor and other interbank offered rates across various currencies, it means navigating a vast and complicated web of reforms and transition efforts, all in various stages of development.

“The complexity isn’t just how to do a transition to SOFR,” Venetia Woo, principal director and North American regulatory strategy lead at Accenture Plc, said referring to the Secured Overnight Financing Rate, the Federal Reserve’s preferred replacement for U.S. dollar Libor. “It’s ‘how do I transition away from the other Ibors. That’s doubly compounded by the jurisdictions that haven’t done a lot of transitioning.”

Randal Quarles, the Federal Reserve’s vice chairman for banking supervision, on Monday urged financial firms to begin “in earnest” the transitions away from Libor. “Clarity on the exact timing and nature of the Libor stop is still to come, but the regulator of Libor has said that it is a matter of how Libor will end rather than if it will end, and it is hard to see how one could be clearer than that.”

To read more about Quarles’s comments, click here.

There’s roughly $370 trillion of financial products tied to Libor and other similar benchmarks, only about $200 trillion of which is U.S. dollar-linked. So from Frankfurt to Tokyo and Zurich, here’s what investors are facing as the world prepares for the death of the much-maligned set of rates:

The Pace Setters

The U.S. and the Secured Overnight Financing Rate

• Since the New York Fed introduced SOFR early last year, trading in futures and swaps has steadily grown, while a cash market is still in the early stages of development.
• Government-sponsored entities such as Fannie Mae and the Federal Home Loan Banks have dominated sales of SOFR-linked floating-rate notes, and financial institutions are increasingly tapping the market as well. Issuance tied to the new reference rate has surpassed $86 billion, according to the Alternative Reference Rates Committee.
• The ARRC -- a group of private-market participants convened by the Fed -- has released recommended fallback language for FRNs and securitizations that are currently linked to Libor, as well as bilateral and syndicated loans.
• It said in a statement Friday it will be consulting with a broad range of stakeholders on fallback language proposals for Libor-related consumer products such as mortgages and student loans. The group is hosting a roundtable Monday in New York to outline steps market participants should be taking to prepare for the end of Libor and Quarles’s remarks were delivered to participants at the event.
• Traders continue to await the creation of a term structure for SOFR. In the meantime, Fed staffers issued a paper in April on inferring term rates from SOFR futures prices.
• Three-month dollar Libor was fixed at 2.4785% on Monday, down 2.4 basis points, the biggest one-day slide since February.

The U.K. and the Revamped Sterling Overnight Index Average

• The U.K. introduced a reformed Sonia a little over a year ago, which has made the reference rate more robust.
• Since then, sterling-denominated financial markets have begun to shift “decisively away” from Libor to Sonia, according to a recent statement from the Working Group on Sterling Risk-Free Reference Rates.
• The group said that the share of pound-related swaps trading using Sonia is “broadly equivalent” to that linked to Libor, and floaters tied to the beleaguered benchmark maturing past 2021 have “all but ceased.”
• Issuers have also begun to price securitizations tied to Sonia, and last month saw the first company seek to switch publicly-sold bonds linked to Libor over to Sonia.
• As in the U.S., British regulators are working on developing a term rate and trying to reduce reliance on Libor in other sterling cash markets, including loans.

Switzerland and the Swiss Average Rate Overnight

• The Swiss discontinued TOIS, an unsecured rate used primarily in swap contracts, in December 2017. The National Working Group on Swiss Franc Reference Rates selected Saron, an overnight benchmark based on data from the Swiss franc repo market, as its replacement.
• Yet using Saron as an alternative for Swiss franc Libor is more complicated. It underpins trillions of dollars of financial products, but more importantly the three-month tenor is used by the Swiss National Bank to guide monetary policy.
• The working group is recommending a compounded Saron as a term rate replacement, which should ultimately pave the way for Saron-linked FRNs.

Taking Their Time

The Euro Zone and the Euro Short-Term Rate

• When it comes to derivatives denominated in the euro, the London interbank offered rate is dwarfed by usage of other similar benchmarks published by organizations within the common currency area itself. More than 100 trillion euros ($112 trillion) are tied to Euribor, which is administered by the European Money Markets Institute, and another 22 trillion euros worth are linked to the Eonia benchmark.
• While use of these non-Libor benchmarks was set to face restrictions starting in 2020 due to revamped European Union standards aimed at combating manipulation, officials agreed in February to give the financial-services industry a two year extension -- through the end of 2021.
• The European Money Markets Institute, in the meantime, is working on reforming Euribor. And proposed changes, if approved by EU authorities, will likely keep the benchmark alive longer than Libor rates, JPMorgan Securities strategists led by Joyce Chang wrote in an April note to clients.
• The European Central Bank is proceeding with plans to debut new Eonia methodology as well as begin publishing its intended replacement, the euro short-term rate, on Oct. 2, seeking to smooth the transition from the former to the latter in the coming years.
• Because the euro short-term rate and Euribor could wind up coexisting for a significant period of time, the transition to new benchmarks may be “slower and smoother,” the JPMorgan strategists said.

Japan, the Tokyo Interbank Offered Rate and the Tokyo Overnight Average Rate

• The Bank of Japan implemented Tibor reforms in 2017 to bolster the reliability and transparency of the unsecured interbank lending rate. The BOJ has identified Tonar -- also known as the uncollateralized overnight call rate -- as its preferred risk-free rate for the yen.
• Working groups are progressing toward transitioning away from yen Libor, with the bulk of reforms slated to begin in the second half of 2019, according to the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks.
• Tonar-based derivatives still need to be created to facilitate the development of a term reference rate, which is unlikely to occur before 2021, according to JPMorgan.

A Different Approach

Canada, the Canadian Dollar Offered Rate and the Canadian Overnight Repo Rate Average

• The Canadian dollar Libor rate was discontinued in 2013 in the aftermath of the rigging scandal surrounding the London interbank benchmarks.
• Canada’s main unsecured rate, the Canadian Dollar Offered Rate, has come under increased scrutiny in recent years amid allegations of collusion among Canadian and foreign banks.
• TD Securities strategist Andrew Kelvin wrote in a note last month that he expects CDOR to remain the “dominant” reference benchmark, since almost 90% of financial instruments referencing a floating rate rely on one- or three-month CDOR.
• Canadian benchmark reform has been focusing on enhancing the long-established Canadian Overnight Repo Rate Average, or Corra. The Canadian Alternative Reference Rate working group has proposed modifying the secured rate to capture more of the overnight market, and if approved, it could be introduced in the first half of 2020.

Australia, the Bank Bill Swap Rate and the Cash Rate

• As with the Canadian dollar, the Libor rate for Australian dollars has also been discontinued.
• Australia’s locally-set bank bill swap rate -- commonly referred to as BBSW -- has also had its share of problems in recent years. But the country will continue to use it, and its methodology has been revised to make it more transaction based.
• Regulators are nonetheless taking advantage of global efforts to update Libor fallback language to strengthen BBSW safeguards. The country’s risk-free cash rate will serve as a common backstop across securities, with an adjustment for the historical spread relative to BBSW.
• Moreover, regulators are encouraging market participants to consider whether BBSW is the most appropriate benchmark for their contracts, especially in the shortest, least liquid tenors.

--With assistance from Christopher Condon and Katherine Greifeld.

To contact the reporter on this story: Alexandra Harris in New York at aharris48@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Boris Korby

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