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Libor Remains a Big Problem, But At Least It’s Getting Smaller

2021-01-25 13:53:30
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Unraveling Libor's massive global derivatives industry just got a little easier.

The rate offered by the London interbank is embedded in swaps and other contracts worth hundreds of trillions of dollars, but it is slated to disappear in the not too distant future. If the transition to replacement rates is not smooth, it can lead to major disagreement in the markets.

A solution going into effect on Monday mitigates that risk for much of the market, although there are still many hurdles to overcome in the benchmark transition. A new protocol has been put in place that allows for automatic removal of Libor and swapping another interest in its place – provided counterparties accept it legal terms that rule the industry. And while it doesn't cover everyone, nearly 12,000 entities – including major banks like Barclays Plc and JPMorgan Chase & Co. – this new method to avoid complicated negotiations with many trading partners.

“It is an important day for the health and safety of the market,” said Jason Granet, chief Libor transition officer at Goldman Sachs Group Inc. "Any new derivatives trade will have appropriate Libor fallbacks. This is going to update the fallback language into millions and millions and millions of transactions. The more information that comes out and the more clarity is provided, the better that is for a smoother overall transition. "

The crucial dollar-Libor rates are likely to last through mid-2023, but other Libors around the world could expire at the end of the year.

That is not the only Libor milestone to be passed on Monday. At 5:00 pm London time, the benchmark manager will stop accepting feedback about its plan to defer interest and pave the way for an announcement, possibly in days, as to when Libors will end around the world.

Analysts hope Monday's events will collectively help address one of the biggest challenges of the Libor transition: how to switch something like $ 200 trillion in derivatives to replacement rates in time, when obvious catalysts to get things moving. getting carried out in an ever smaller supply.

The new protocol from the International Swaps and Derivatives Association will help companies that have not made arrangements to leave Libor without much extra effort.

“Having a downturn based on a clear, consistent and transparent methodology will significantly reduce the risk of market disruption if a major Ibor ceases to exist or if Libor is considered unrepresentative before the transition efforts are complete,” said Scott O & # 39; Malia, ISDA & # 39; s chief executive officer, said in a statement press release.

It's "a really efficient and healthy way for counterparties to tap into the legacy population," said Tyler Wellensiek, general manager of rate sales at Barclays. However, "it really is a safety net, and it is in no way the only piece of the puzzle."

Complications

One of those other pieces is what to do with loans linked to Libor as they are not covered by the ISDA framework. Parties to those deals will still have to manually figure out what to do when the rate ends.

“There are still many unsolved complications in this area, and certainly many open questions,” said Padhraic Garvey, head of global debt and interest strategy at ING Groep NV. That also includes how derivatives switched to fallback rates would behave against underlying loans, he added.

Help may be on the way to fix some of these other issues. For example, New York Governor Andrew Cuomo this month proposed legislation that would make it easier for contracts linked to Libor to switch to a different rate. Much of the Libor market is governed by New York law.

In addition, the main clearinghouses for derivatives are LCH Ltd. and CME Group Inc. floating plans to shift swaps worth more than $ 150 trillion from Libor in the weeks before the benchmark ends.

Libor Death

The focus is zero when various Libor rates expire, something ICE Benchmark Administration Ltd. expected to clarify in the coming weeks. The crucial dollar-Libor rates are likely to last through mid-2023, but other Libors around the world could expire at the end of the year.

This announcement would be the "biggest deal in the Libor transition" since 2017 and could result in "huge moves" in euro dollars, a major derivatives market linked to interest rates, said Priya Misra, head of global interest rate strategy at TD Securities. in New York City.

That's because the news would trigger Libor's fallback calculations – essentially a mathematical equation that determines the speed of Libor's replacement. Speculation about the timing of the announcement shocked the euro / dollar market in December as even a slight shift in spread calculations could flood portfolios.

According to the announcement itself, euro dollars maturing in September 2023 or beyond could move as much as five basis points, Misra said.

However the market reacts, regulators can bolster their decision when another tipping point transition moment passes with little change. While some progress has been made, the average open interest rate in three-month futures on the Secured Overnight Financing Rate – the heir to Libor in the US – is hardly exceeded 5% that of euro / dollar contracts last month.

“In recent years there has always been the question:" Will it be carrot or stick? Said Marcus Burnett, director of SOFR Academy, an education technology company with clients including banks, asset managers and law firms. & # 39; We now know. The supervisory sector will put more pressure on the banks. Central banks in a number of markets around the world are also considering the sanctions they could impose. "

–With help from Edward Bolingbroke, Stephen Spratt, and Liz Capo McCormick.

Top photo: Commuters cross London Bridge to see skyscrapers in the City of London skyline in London, UK, on ​​Thursday, October 15, 2020. Photographer: Simon Dawson / Bloomberg.

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