LIBOR is one of the most commonly used interest rate benchmarks in global financial markets. Its publication is expected to cease by the end of 2021.
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.
Certain funds and mandates will use LIBOR in their investment objectives, performance fee calculations, asset allocation models and comparators. The 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 Financial Conduct Authority (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.
Over time, 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.
The FCA and the Bank of England jointly published a factsheet on 16 January 2020 which gives further information about the transition.
If you require any further information, or have any questions or concerns relating to LIBOR transition, please contact your relationship manager or financial advisor.
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 is expected 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 will, where possible, 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.
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):
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 ICE Benchmark Administration 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?
Our base case at Man Group is that LIBOR will cease by end-2021. This is when the FCA has said it will no longer persuade or compel panel banks to provide submissions to LIBOR. At any time following this date it is possible that ICE Benchmark Administration may cease to publish the rate.
The EU Benchmark Regulation (BMR) also has a “representative test”, which in the context of LIBOR requires the FCA to make an assessment of LIBOR’s representativeness in certain circumstances, such as the departure of one or more Contributing Banks, or in any event, every two years.
However, 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 will also increasingly refer to the new RFRs. The timing for this 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 currently expects the stock of LIBOR-referencing contracts to significantly reduce from Q1 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.
What could the reforms mean for Man Group’s clients?
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 Floating Rate Notes (‘FRN’) issuers to change the rate from LIBOR to the relevant RFR plus an adjustment spread).
It is important to note that, for certain instruments and arrangements, Man Group will not have control over the transition away from the LIBOR rate. A number of cash instruments 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 will carefully monitor 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.
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 will work 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 are developing a comprehensive internal LIBOR transition project plan to manage the associated risks.
We are carrying out an assessment to determine the impact of the transition for our clients and our business. We are monitoring this situation and, where required, will update clients with further information.
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.
We will be contacting our clients to discuss what this means for them by the end of Q4 this year.
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 addition, should you seek general information on LIBOR transition, please consider reviewing published information from regulators, working groups and other industry bodies.
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.
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