Is 2021 the end of LIBOR? Spoiler – it’s not
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.
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