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In March of this year the Financial Conduct Authority (FCA) announced that most LIBOR settings will permanently cease or no longer be representative from 31 December 2021, while immediately after 30 June 2023, the most widely used USD LIBOR tenors will either cease publication or no longer be representative.
The 2023 deadline for the most widely used USD LIBOR tenors offers the market some breathing room but firms must not relax their efforts. Instead they should continue to forge ahead with their transition plans.
The new risk-free rates (RFRs) differ from LIBOR rates. Alternative RFRs are based on overnight repos or deposits and are backward looking, in contrast to LIBOR, which has six forward-looking tenors (plus one overnight rate) out to one year.
Although many markets will be able to switch from LIBOR to overnight RFRs, there are some markets for which a term structure is essential. In the UK, the Working Group on Sterling Risk Free Reference Rates identified a number of segments of the loan market such as trade finance, emerging markets, mid-sized corporates, SMEs, private banking, retail mortgages and Islamic finance products, which are well suited to use forward-looking term rates. These markets tend to either require a term structure to operate or the use of overnight RFRs is not well suited to the market participants.
Problems relating to the LIBOR transition go beyond new issuance not well aligned to RFRs and also include legacy contracts. Recent estimates from the ARRC - a group of private-market participants convened by the Fed to help ensure a successful transition from USD LIBOR rates - suggest that legacy exposures referencing USD LIBOR could be in the region of $220 trillion.
Although many of these instruments relate to derivatives or will have expired by June 2023, the market could still be left with roughly a five trillion USD exposure in USD LIBOR referencing cash products (e.g. loans, bonds and securitised products), constituting a significant concern.
One of the key issues is that legacy LIBOR contracts may not have suitable fallback language that is able to cope with permanent USD LIBOR cessation. New LIBOR legislation recently signed into State of New York law reduces the adverse economic outcomes of legacy LIBOR fallback language. Where the contract has no fallback or the fallback is based upon LIBOR, the law strikes out any existing language and replaces it with the ARRC's recommended fallback language.
The ARRC has issued recommended fallback language specifying that contracts with that language would fall back to forms of the Secured Overnight Financing Rate (SOFR) plus a fixed spread adjustment.
As the LIBOR transition deadline approaches, robust data and innovative tools will deliver invaluable support to firms as they seek to maximise efficiency and minimise disruption in their day-to-day activities. What are the next steps in the LIBOR transition and where are you? Join us in an upcoming webinar to consider the remaining steps for the move away from LIBOR, with a look at how data can support transition efforts, both in the sterling market and across other currencies. If stage 1 in your LIBOR transition was, ?how am I impacted by this and which data sets do I need??, in this webinar we address stage 2: ?where is the rest of the market and the industry in the transition and how can I use these new data sets to best effect?
Jacob Rank-Broadley, Head of LIBOR Transition, Benchmarks & Indices, Refinitiv