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This blog explores key areas of the obstacles observed during our IBOR transition implementations, with brief outlines for preventative measures and solutions. While not exhaustive, we see these as determining factors of the transition, particularly for asset owners and their managers but also for market participants that are exposed to the transition more generally.
Client priorities ? Mandating asset managers is one of the principal actions that begin the transition. Since asset owners work with multiple brokers in different stages of the transition with their client base, in a sense they have tended to rely on brokers' best-execution obligations to time the transition. This is particularly the case for portfolios with significant exposure to tough legacy contracts. We recommend that asset owners initiate discussions and agree on a plan as soon as possible given the five months to cessation, even if the intent is to subsequently execute the book's transition in one go . An earlier start will allow asset managers more time to adjust, and such client involvement will help incentivise managers to engage sooner.
Pricing - Basis risk, consensus on the credit spreads and term rates, treatment of USD LIBOR exposure and a potential choice of non-LIBOR alternatives remain significant factors. Investment managers should identify portions of the portfolio for active conversion and initiate bilateral consensus discussions. Determining the scope of affected agreements remains a focal point as systems may not be in tune with the existing documents. Karol Kurkowski, Head of Financial Markets Contracts, Standard Chartered Bank notes:
?A key factor is the compensation issue as a result of the rate change. This is especially relevant for dealers with significant trading volumes. Amendments for new rates can't be smoothly executed as business struggles to agree on the payment - ESTR 8.5 is a solution as equal to EONIA, but not all clients are happy with such a solution.?
Customer engagement - Early client communication facilitated by sales is essential to hasten the transition. An absence of alignment in non-financial incentives has proved to be a considerable obstacle. Most communication has been sequential and non-personalised. A natural solution would involve a shift from general customer education to personalised touchpoints to ensure client readiness and avoid conduct risk. Specific, tailored, and harmonised communication will ensure confusion is minimised and disruption is avoided.
Transition challenges - As Joe Kohler, Partner, Reed Smith notes:
?What makes a contract a tough legacy one is the extreme difficulty of repapering it to ensure it uses either risk-free rates, or up-to-date fallbacks. The challenges come in many shapes and sizes and affect different asset classes. However, in my experience, it can sometimes be difficult even knowing where to start: IBOR references can be ingrained throughout the various constituent agreements, and each agreement can have unique complications - a counterparty without the means to agree to changes, cashflow mismatches, etc. When change risks the whole edifice falling down, there is a powerful argument for a legislative solution.?
After agreeing on the transition plan, we recommend that managers create a repeatable process. This starts with the selection of clients with a healthy variety of portfolio characteristics. Such a strategy will help iron out issues early while addressing various challenges during the transition. CDCA also recommends executing dry runs in a controlled environment to test the coordination among the different moving parts. Taking these elements into consideration will significantly influence transition success. For more information, email us at email@example.com
Alexander Tealdi, Intern , CDCA