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December 2021 has been etched into our minds for the last 3
years as the end date for LIBOR. Ever since Andrew Bailey's
announcement in July 2017 that panel banks will no longer be
compelled to submit to LIBOR after this date, the industry began
planning for a world without LIBOR from January 2022 onwards. With
LIBOR hardwired into trillions of dollars' worth of financial
contracts ranging from derivatives to student loans, this
transition represents one of the biggest challenges to the
financial system and its participants. However, some recent
announcements from the ICE Benchmark Administration (IBA) now means
December 2021 may not be the end of LIBOR.
On November 18th, 2020, the IBA (the administrator of LIBOR)
announced it will consult on its intention to cease LIBOR
publication on all CHF, EUR, GBP and JPY LIBOR settings on December
31st, 2021. On November 30th, IBA followed up with another
announcement on its intention to cease USD LIBOR settings on 1W and
2M on December 31st, 2021 and more significantly to cease
publication of USD LIBOR for all other tenors on June 30th,
2023.
The announcements can be split into 3 key
parts:
Major currencies CHF, EUR, GBP and JPY EUR have an expected
cessation date of December 31st, 2021
USD 1W and 2M tenor are expected to end on December 31st,
2021
All other USD tenors are expected to end on June 30th,
2023
The first two contain no major surprises. However, the last
announcement which is effectively an 18-month extension to USD
LIBOR, is one of the most significant updates since the beginning
of the transition process. The intention of the extension is to
allow a more orderly unwind for those legacy positions which do not
have an easy means to transition and was based on feedback and
discussions the IBA had received from panel banks and regulators.
The announcement was followed shortly by statements of support by
the main IBOR governing bodies (AARC, Fed and FCA), with the FCA
providing assurances to the continued representativeness of USD up
to June 2023 and therefore avoiding the possibility of a "Zombie
LIBOR".
So, what does this announcement mean for the LIBOR timeline?
While this may sound like some much-needed reprieve in the push to
migrate positions in the next 12 months for some market
participants, the overall message is still clear that LIBOR
exposure should continue to be actively transitioned in 2021. The
Fed warned that no new LIBOR exposure should be opened after
December 2021, unless for a set of limited use cases (hedging or
novation). So, the end of 2021 deadline still holds for new
products. While a final approach has not yet been agreed,
this usage post December 2021 will likely be policed in some way by
the FCA. Combined with the FCA potential new powers for "tough
legacy" contracts which will compel IBA to publish a synthetic,
non-representative version of LIBOR post December 2021, it is clear
LIBOR is not quite on the way out just yet.
What this does mean is Q1 of 2021, an already critical quarter
in the IBOR timeline, will take on additional importance. The IBA
consultation on their intended cessation dates is expected to close
at the end of January 2021. This consultation will clarify the
final cessation dates for the five major currencies simultaneously
even if those dates are expected to be different. This adds to
existing milestones already pencilled in for Q1 including January
25th, 2021 when the IBOR Fallback Supplement will come in effect.
From this date, the standard definitions for interest rate
derivatives on cleared and non-cleared trades will incorporate the
new ISDA fallbacks. Contracts entered into before January 25th,
2021 will have a chance to adhere to the new Supplement via the
IBOR Fallback Protocol. We are also expecting consultations on FCA
tough legacy methodology and Euro Working Group statement on the
future of EURIBOR to be published in Q1 of this year.
ISDA were clear to say that this announcement is not an "Index
Cessation Event". An "Index Cessation Event", which will fix the
spread adjustment used in the ISDA Fallback, was expected sometime
in Q1 however some have now questioned if it makes sense to fix the
USD spread two and half years before the fallback will actually
kick in. Should the date of the spread fixing also get extended,
this will change the 5Y window used in the spread calculation.
Given the expectations of continued low interest rates, this will
likely reduce the final spread adjustment used and therefore impact
the price of those contracts still referencing LIBOR after the
permanent cessation. A consequence of this announcement, we are now
potentially looking at split timelines for pre-cessation and
permanent cessation event dates for the major currencies.
New Transition TimeLine
If we look at the dispersion of maturities for USD interest rate
swap trades, only a small proportion of swap
positions mature between December 2021 and the new cessation date
of June 2023. The data below was taken from our Derived Data and
Valuation Service database and shows most USD swaps expier after
June 2023 and would therefore require active transition mechanism.
The extension does little to reduce the exposure for derivatives to
USD LIBOR cessation date, however, it will provide more time to
manage that exposure before the deadline. One potential benefit
related to this point is for contracts relying on term rate as
their transition mechanism. A SOFR term rate is expected in Q2 2021
and allowing more time for the SOFR derivatives liquidity to build
in order to adopt the term rate could be a key
factor. Many see the availability of robust term rates as
the biggest obstacle for the transition, particularly for the cash
market.
Source: IHS Markit Derived Data and
Valuation Services
While this extension will provide some additional flexibility,
mainly in the "tough legacy" space, we expect the
transition effort for most LIBOR linked contracts to continue as
planned. As mentioned earlier, the message from the
governing bodies to continue to actively transition away from LIBOR
and the USD extension should not be a reason to avoid
adherence to the ISDA Fallback Protocol or delay preparations.
There are still many important questions and challenges in the
IBOR transition space. From the timeline and availability of term
rates, how to account for the lack of dynamic credit risk in the
ISDA fallbacks, how will more complex and nonlinear derivatives
transition, how different cessation timings may impact cross
currency contracts and so on... The hope is that the announcements
expected over the coming weeks will provide additional clarity on
the LIBOR end game. With time still left for further twists and
turns, it is imperative for the firms exposed to LIBOR to monitor
these announcements carefully as the push to transition
intensifies.
Posted 12 January 2021 by Alex Kenny, Director, Derivatives Data and Valuations Services, IHS Markit and
Julien Rey, Executive Director, Financial Services, Head of LIBOR Transition Program, IHS Markit
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