Libor Transition: Five Points Firms Still Need to Consider
Six years ago the now Governor of the Bank of England, Andrew Bailey announced that “the survival of Libor [London Interbank Offer Rate] could not and would not be guaranteed past end 2021”.
In that time the markets have transitioned from what was described as “the world’s most important number” by the British Bankers Association linked to more than $300 trillion worth of contracts globally, to a range of overnight risk-free rates (RFRs) that can be used across all assets, including loans, bonds and derivatives.
While the transition has so far proved a success, there are still four synthetic Libor settings remaining; 3-month synthetic sterling Libor and 1-, 3- and 6-month synthetic US dollar Libor. The sterling setting is due to end in March 2024 while the US dollar Libor will follow in September.
As the switch to alternative risk-free rates (ARRs) continues, we provide five points market participants should consider as they prepare for the next round of deadlines;
What plans do you have in place to manage liquidity constraints? In part due to macroeconomic conditions and interest rate volatility liquidity in some products - such as SONIA futures and options - has been constrained. Market participants need to understand their Central Bank’s desire to use interest rate changes and open market operations to effect monetary policy. Further, think about the access to a diverse and appropriately liquid set of underlying instruments to manage risk.
Are you flexible enough to apply different RFRs across your products?
It is important in the new multidate environment, that market participants are aware of all of the available rates, their conventions and applicability for specific products.
How well are the operational processes, and those of any third parties in your workflow, able to cope with spikes in Repo volumes? SOFR, which references the rate paid by borrowers in overnight repo transactions collateralised by US Treasuries – can be prone to volatility spikes. Market participants need to have systems in place that will limit the impact and ensure stability for clients.
How adequate is your RFR stress testing? The new RFR instruments have less than five years of history, but many regulations and capital adequacy regimes require history back to 2007. It is important to have stress tested your RFR portfolio for standard events that occurred over the past 15 years.
What is your strategy to deal with new basis risks? There may be differences in the rates used to reference liabilities compared to those used for assets. Firms need to be sure they can manage these legacy exposures.
After years of hard work, the Libor transition is nearly complete, but market participants need to keep their focus to avoid any unexpected complications. Parameta Solutions global subject matter experts prioritise solving market problems and are well placed to help your organisation in the final stages of the journey. https://bankofengland.co.uk
After years of hard work, the Libor transition is nearly complete, but market participants need to keep their focus to avoid any unexpected complications.
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