LIBOR is one of the most commonly used interest rate benchmarks in global financial markets. Its publication will, for the majority of currency tenors, cease by the end of 2021. In particular, the UK Financial Conduct Authority (FCA) has announced that that all LIBOR settings for all currencies will either cease or no longer be representative immediately after the following dates:
- For Euro, Swiss Franc, Sterling and Japanese Yen LIBOR settings in all tenors, and US Dollar LIBOR 1-week and 2-month settings; 31 December 2021
- for US Dollar Overnight, 1-month, 3-month, 6-month and 12-month settings 30 June 2023;
- Note that the FCA will consult on the continued publication of 1- month, 3-month and 6-month sterling LIBOR for a further period after end-2021 on a changed methodology basis (also known as a “synthetic LIBOR”) basis using the proposed new powers the government is legislating in the Financial Services Act;
- the FCA will consult on the continued publication of the 1-month, 3-month and 6-month Japanese yen LIBOR settings after end-2021 on a synthetic basis, for one additional year;
- as the transition away from US dollar LIBOR progresses, the FCA will continue to consider the case for using the proposed powers mentioned above to require continued publication, on a synthetic basis, of the 1- month, 3-month and 6-month US dollar LIBOR settings for a further period after end-June 2023.
Interest rate benchmarks, such as LIBOR (the London Interbank Offered Rate), are widely used to calculate the interest rate in financial products. The rates are written into loans, bonds, derivatives and many other financial contracts and investments. Globally, a number of regulators have recommended that firms should cease issuing new contracts referencing LIBOR as soon as possible and, apart from in very limited circumstances, by 31 December 2021. In the UK, the Working Group on Sterling Risk-Free References Rates has recommended that by end-Q1 2021, firms should cease initiation of new GBP LIBOR-linked loans, bonds, securitizations and linear derivatives that expire after the end of 2021.
Certain funds and mandates will use LIBOR in their investment objectives, performance fee calculations, asset allocation models and comparators. LIBOR benchmark is also relied on by financial firms from an operational perspective, including in valuation curves, stress testing, pricing and asset allocation models.
LIBOR has been the most widely used interest rate benchmark for many years, but in July 2017 Andrew Bailey, then Chief Executive of the UK’s FCA, announced that, from end-2021, the FCA would no longer persuade or compel LIBOR panel banks to continue contributing to the rate.
Global regulators, including the FCA which has regulated LIBOR since April 2013, are encouraging the development and transition to alternative ‘Nearly Risk Free Rates (aka ‘Risk Free Rates’ or ‘RFRs’) as a priority. See “What is replacing LIBOR” section below for further details on RFRs.
For Man Group, it’s important that our clients and other stakeholders fully understand the potential impact of LIBOR’s end on their investment portfolios. To facilitate the LIBOR transition process, we have established and are implementing a LIBOR transition plan.
Throughout Q3 2021, we will be contacting clients directly to outline our intended approach to transition. For now, we have set out here some key details regarding these changes that we think you should be aware of.
If you require any further information, or have any questions or concerns relating to LIBOR transition, please contact your relationship manager, or email us at our dedicated email address: IBORQueries@man.com.
LIBOR is being phased out
Since the 1980’s LIBOR has been used widely as an interest rate benchmark for a large number of financial products and services. The rate is based on panel banks’ submissions of their interbank borrowing rates. These submissions were generally intended to be based on actual transactions in the interbank market.
However, since the financial crisis, banks have shifted away from unsecured interbank lending in favour of alternative funding models. This reduction in the volume of unsecured interbank lending has led to decreased liquidity in the underlying market.
This absence of an underlying active market means LIBOR is now largely sustained by the use of “expert judgement” from the panel banks submitting the quotes that determine the rates.
The FCA’s view is that this cannot continue indefinitely, and 2021 is the last year that panel banks have agreed to participate in providing their submissions to LIBOR.
LIBOR to cease after end-2021
The FCA announced in 2017 that it would no longer seek to compel or persuade panel banks to submit the rates required to calculate LIBOR after the end of 2021.
Financial products need to remove dependence on LIBOR by the time the rate ceases to be published in order to avoid disruption.
In some cases, particularly in the cash markets, introducing robust fallbacks to LIBOR is likely to be challenging where high levels of investor consent is required - although there has been some progress to date. For example, we are aware that there have been a considerable number of successful consent solicitations across different product types (including Floating Rate Notes (FRNs) and covered bonds) and regulators are encouraging firms to seek consent from bondholders where possible.
What is LIBOR?
LIBOR represents the average interest rate that a bank would be charged by other banks for an unsecured loan over a specified term in a specific currency. It is calculated and published daily by the Intercontinental Exchange (ICE) Benchmark Administrator (IBA).
At the time of writing, each LIBOR calculation is based on interest rates (input data) received from a panel of between 11 and 16 Contributor Banks for each of the five LIBOR currencies.
IBA calculates LIBOR as an average from the interest rates submitted by the Contributor Banks, based on what they would be charged if they were to borrow from other banks.
LIBOR is calculated for five currencies (USD, GBP, EUR, CHF and JPY) and for seven tenors/terms for each currency (Overnight/Spot Next, One Week, One Month, Two Months, Three Months, Six Months and 12 Months).
35 individual rates (one for each currency and tenor/term combination) are published each London business day.
Why is it being replaced?
Since 2014, global financial regulatory authorities have expressed concerns about the reliability and robustness of existing interbank benchmark rates.
In 2017, both the FCA and the Bank of England noted that it had become increasingly apparent that the absence of active underlying markets and the scarcity of term unsecured deposit transactions raised serious questions about the future sustainability of the LIBOR benchmarks.
In an example used by the FCA, in one currency–tenor combination for a daily benchmark rate, between them the contributing banks had executed just fifteen transactions of potentially qualifying size in that currency and tenor over a 12-month period.
Without sufficient transaction data, LIBOR submissions made by banks to sustain the LIBOR rate are largely based on expert judgement of contributing banks - rather than actual transactions, which heightens the risk of benchmark manipulation.
By contrast, Risk Free Rates are based on overnight lending markets figures - which are generally considered to be more liquid.
In the FCA’s view, not only was it potentially unsustainable, but also undesirable, for market participants to rely indefinitely on LIBOR, which increasingly uses reference rates that do not have active underlying markets to support them.
The FCA received a voluntary agreement from the LIBOR panel banks to continue to submit to LIBOR until end-2021, to enable time for the market to transition away from LIBOR.
What is replacing LIBOR?
Public-private sector working groups established in the jurisdictions of the five currencies below have identified overnight RFRs to replace LIBOR and EONIA, as follows (EONIA is also being replaced along with LIBOR):
(Please see “What are the key upcoming dates and milestones?” section below which outlines some of the key regulatory milestones associated with transition of the below rates in 2021.)
What do we know about these risk-free rates?
While the singular term ‘RFR’ suggests something fairly generic, it can be seen from the table above that in fact each RFR is different from the other.
While IBA is the sole administrator for LIBOR, the RFRs are mainly administered by central banks in the jurisdiction in question.
While LIBOR is calculated based on a consistent basis, the RFRs are a mix of secured and unsecured rates, some for example based on the overnight repo market and others based on overnight wholesale deposits.
The RFRs are different therefore to LIBOR, but also to each other (they are also published at different times to LIBOR and each other).
RFRs are calculated on a different basis and are not like-for-like replacements for LIBOR. RFRs are overnight rates which are backward-looking, i.e. are published after the period to which they relate.
LIBOR, on the other hand, is set at or prior to the commencement of the period (or term) to which they relate, allowing certainty during such a period over amounts which will be due at the end of that period.
LIBOR and most other IBORs are intended to measure unsecured interbank lending rates and, as a result, include or imply a credit spread.
The proposed RFRs are based on short-term wholesale transactions for unsecured RFRs (i.e. SONIA, TONA and €STR) and repurchase or “repo” transactions for secured RFRs (i.e. SOFR and SARON which does not form part of the RFRs. The RFRs are therefore nearly risk free and so do not include or imply a credit spread of the type seen in LIBOR.
To transition existing contracts and agreements that reference IBORs to the RFRs, adjustments for credit and term differences may need to be incorporated and applied to the alternate rate to avoid, to the extent possible, a value transfer.
Any spread adjustment applied to an RFR will only serve as a rough proxy for the historic delta between a LIBOR currency/tenor and the relevant RFR.
In some instances, it may not be appropriate to amend a LIBOR reference to the relevant RFR. Alternative solutions may need to be used depending on the product or instrument in question.
It is worth noting that several of the RFRs are relatively new rates which do not have extensive historical performance data.
A high-level summary of the key differences between LIBOR and RFRs is set out below.
What are the key differences between LIBOR and RFRs?
There are a number of differences between the alternative RFRs and LIBOR:
When will the transition take effect?
On 5 March 2021, the FCA, announced that all LIBOR settings for all currencies will either cease or no longer be representative immediately after the following dates:
- 31 December 2021, for Sterling, Euro, Swiss Franc and Japanese Yen LIBOR settings in all tenors, and US Dollar LIBOR 1-week and 2-month settings; and
- 30 June 2023, for US Dollar Overnight, 1-month, 3-month, 6-month and 12-month settings
The FCA is also expected to consult later in 2021 on the publication of certain LIBOR settings on a 'synthetic' basis (a different calculation methodology) after the aforementioned dates to potentially support the transition of 'tough legacy' contracts (contracts that are expected to be particularly difficult to transition) in limited circumstances.
Due to the agreement it has with LIBOR contributing banks to remain on the LIBOR panels until end-2021, the FCA has said that it does not expect LIBOR to cease or become non-representative before end-2021.
New contracts are increasingly referring to the new RFRs. The timing for the volume of such contracts will vary depending on the type of contract, any laws relating to it, and when robust systems and procedures required to support the RFR in respect of such contracts become available.
Man Group expects the stock of LIBOR-referencing contracts to significantly reduce during the course of 2021. Likewise, we expect the stock of RFR-referencing contracts across the rates to increase throughout the period and for liquidity to continue to develop throughout Q2 2021 and beyond.
How could the reforms impact portfolio investments?
Where you have investments in your portfolios with us that reference LIBOR, it seems likely that these will need to be transitioned to RFRs, for example through updates to “fallback language” that can be used when LIBOR permanently ceases to be unavailable (or is declared unrepresentative), through the active trading out of LIBOR positions, or through amendments (such as consent solicitation exercises by (FRN issuers to change the rate from LIBOR to the relevant RFR plus an adjustment spread).
In the context of bilateral OTC derivatives, each fund managed by Man Group or any of its affiliates or subsidiaries has adhered to the ISDA 2020 IBOR Fallbacks Protocol (Protocol), which applies fallbacks in respect of certain IBORs on and from the first London business day after they cease to be published or be representative.
The key fallback rate for permanent cessation or a declaration of unrepresentativeness is calculated by compounding the relevant RFR daily over the tenor of the relevant IBOR (e.g. 3 months for 3-month GBP LIBOR), and applying a fixed credit adjustment spread that is the 5-year median of the historical difference between the relevant RFR and the IBOR it is replacing.
Whilst the Protocol intends to address IBOR transition risk in the bulk of over-the-counter derivatives transactions (and a number of other bilateral master agreements), the Protocol is not necessarily a complete solution for remediating non-linear derivatives transactions such as swaptions, constant maturity swaps or transactions involving interest rate caps and floors, or range accruals. Man is actively monitoring industry developments in respect of non-linear derivatives and engaging with these as appropriate.
For certain instruments and arrangements, Man Group does not have control over the transition away from the LIBOR rate. A number of cash products in particular require consents and approvals. For example, where a fund is invested in a FRN linked to LIBOR it will be the issuer and relevant noteholders of the requisite majority that will ultimately determine the timing if any for transition.
We are carefully monitoring liquidity and other relevant factors both in the LIBOR and the alternative RFR market and manage and time the transition process to best manage the potential risks.
We are continually assessing how the transition may impact IBOR-referencing investments, while closely monitoring market developments.
Risks involved in benchmark reform
It is not possible to provide an exhaustive list of the risks involved in benchmark reform, which are many and varied (including between currency, tenor and relevant product). This section sets out some examples for your information only.
Where it is not possible to amend an existing LIBOR exposure to the relevant RFR (a process known as ‘remediation’), by the time LIBOR ceases to be published (or is declared unrepresentative by the FCA), that asset is unlikely to function or perform as originally intended, its price may be negatively impacted or value transferred, and it may become illiquid and hard to value.
Note that beyond LIBOR, other IBOR benchmarks are also affected by global benchmark reforms, including TIBOR, HIBOR, EONIA, CDOR and BBSW. The timings for transition from such rates vary, but the broad risks set out in this section apply generally to other affected IBOR rates.
It may not be possible to transition certain assets from LIBOR to the new RFRs, or to transition a certain trades and their underlying positions at the same time, causing a mismatch or ‘basis risk’. Transition is likely to be particularly difficult for assets issued to multiple investors or with high consent thresholds to amend the rate. Delays or failures in obtaining investor or counterparty consent, or regulatory approval, may adversely impact transition.
In comparison to LIBOR, some RFRs are relatively new interest rate benchmarks and how these rates, and any adjustments, will perform in stressed market conditions or over significant time periods is not well established.
Industry and market solutions for transition from LIBOR to RFRs across different asset classes and currencies are not aligned and are developing at different rates.
RFRs and LIBOR do not operate on the same basis. Remediation from LIBOR to RFRs may lead to market participants paying more or receiving less on an asset than if it had remained a LIBOR-referencing asset. Spread adjustments applied to RFRs to reflect the historical difference in performance with LIBOR are rough estimates and will not perfectly match the performance of the relevant LIBOR rate it replaces, meaning that some value transfer is inevitable.
Remediation may alter the legal, commercial, tax, accounting or other economic outcome of the relevant trade(s), including as between a trade and its hedge, in ways that may be difficult to predict with certainty.
For new investments, including where an existing LIBOR-asset is sold and replaced with an RFR-referencing asset during transition, the market in the relevant RFR-referencing asset may lack liquidity and/or price transparency, particularly when compared with historical LIBOR volumes, which may make the asset more difficult to buy or sell.
What is Man Group doing to understand the potential impact on clients?
We recognise the importance of the industry led initiatives in relation to RFRs and are aware that LIBOR transition will be of particular interest to our clients.
We are working closely with regulators, market participants and industry bodies as well as participating in industry discussions and following developments in this evolving area so that we can adopt approaches and strategies that are consistent with and support industry best practice.
The impact of the transition will not be the same for all investment funds, portfolios, products and mandates that we manage, and we are working with our clients to understand the specific implications for each of them.
What is Man Group doing to mitigate the potential impact on clients?
We support the market transition away from LIBOR and are committed to working closely with our clients to ensure they are aware of and understand the potential impacts.
There is no one-size-fits-all solution to the LIBOR challenge, and we fully appreciate the complexity and scale of the transition exercise. We have a dedicated team of experts responsible for this task and have established and are in the process of implementing an internal LIBOR transition project plan to manage the associated risks.
We have carried out an assessment to determine the impact of the transition for our clients and our business, identifying instruments and products which carry a LIBOR exposure.
What is Man Group’s approach to LIBOR transition?
We are working towards the transition away from LIBOR for all our clients by the end of 2021 at the latest in line with market developments and regulator expectations.
Our deep dive analysis of Man Group fund products has shown that we have only four active IBOR currencies (GBP LIBOR, USD LIBOR, EURIBOR and SEK IBOR). As USD LIBOR will continue to be published until June 2023 (see above), EURIBOR has been reformed (with publication expected to continue until at least 2025), and SEK IBOR is likewise expected to continue, our product-level focus for 2021 is GBP LIBOR.
We will be contacting our clients to confirm the approach and discuss what this means for them by the end of Q3 2021.
Do clients need to do anything now?
We are pro-actively preparing for LIBOR transition and we encourage our clients to do so as well.
There are a number of potential steps that you may wish to take now:
- Review the latest industry information available on LIBOR discontinuation;
- Identify any investments you have which reference LIBOR and engage with us to determine next steps; and/or
- Consider seeking advice from your financial and/or legal advisers.
Where to obtain more information?
We will seek to update this page periodically as market developments occur and industry announcements are made. In the meantime, if you require any further information, please contact your relationship manager or email us at our dedicated email address: IBORQueries@man.com.
In addition, should you seek general information on LIBOR transition, please consider reviewing published information from regulators, working groups and other industry bodies.RFR Working Group
More information on SONIA and LIBOR transition in the UK is available from the RFR Working Group.
The Bank of England and the FCA has information on LIBOR transition available on their websites.
Beyond the UK, the U.S. Commodity Futures and Trading Commission (CFTC), the Federal Reserve Bank of New York (FRBNY), the U.S. Alternative Reference Rates Committee (ARRC), the European Central Bank (ECB), the Financial Stability Board (FSB), the International Organization of Securities Commissions (IOSCO) and some of the working groups and industry bodies that are considering these issues have published information which can be found on their websites.
What are the key upcoming dates and milestones?
Please have a look at the LIBOR Milestone Timeline here.
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