The end of LIBOR – Rumors of my death have not been exaggerated (RODNE)

This review of the transition from LIBOR markets, initiated by the FCA statement in July  2017, was written in September 2017, whilst in a previous life. It remains relevant, albeit out of date. The full document was long and intended to provide a glossary of the issues clients would face as we progressed towards the “death of the iBors”.

We have broken it up into segments here, and will work to update each when time allows. In the meantime, individual sections will prove useful background for forthcoming posts, eg here.

            “Look on every exit as being an entrance somewhere else”                 
                           Tom Stoppard, Rosencrantz and Guildenstern Are Dead

Exec Bullets/Key takeaways.

• We can see no clear evidence that we shouldn’t take the FCA at their word, and assume that sometime around 2021, perhaps with a short delay, LIBOR will have retired.
• The loss of LIBOR will impact, either directly, or indirectly, many markets.Regulators in each of the affected markets have started to pursue alternatives, but each proposal carries technical and philosophical difficulties.
• The market impact varies from significant and potentially existential, regarding swaps and their use in LDI hedging strategies, to minor in foreign exchange. Furthermore, the proportion naturally running off over the next five years will substantially reduce disruption, notable in the interest rate derivatives markets which are the majority of the exposure to LIBOR.
• We’re taking the process seriously……

In a speech given on July 27^th 2017 Andrew Bailey the Chairman of the UK Financial Conduct Authority (FCA)responsible for LIBOR, announced the planned phasing out of the benchmark – in sum, that global regulators were unanimous that LIBOR needs to go. It was a surprise to most of the market, though received little press. Bailey said it’s not related to the LIBOR scandals – instead it’s simply that there aren’t enough transactions to sustain the benchmark. It’s unacceptable to rely on “expert judgment” of industry insiders to set the daily rate estimates within markets that saw fewer than 20 transactions in a year. LIBOR is the basis for hundreds of Trillions of dollars’ worth of securities worldwide, andits retirement process challenges the health of the financial system.

The questions raised by the death of LIBOR deserve a broad and thorough coverage. However, we’re at the early stages of a 4-plus year process, and we wanted to bring to our client’s attention, all of the major issues. Therefore, we’ve published this technical document (RODNE) designed to cover the details of what’s happening to each of the major currency regimes in which LIBOR operates.

We’ve also composed shorter notes where we explain what it likely means for clients who use specific LIBOR products.

Index – Click on each “part” title below to go straight to that section

1. Part 1 – Libor – from whence it came
   1. The foundations of LIBOR
   2. The “ibor diaspora” – LIBOR, TIBOR & EURIBOR.
   3. LIBOR’s troubled past
   4. Can’t we just forgive and forget, and move on with LIBOR?
   5. How could such a flawed instrument have become so ubiquitous?
2. Part 2 – The Fixes
   1. Light is starting to emerge from the tunnel – is it an alternative benchmark?
   2. The US approach – a case study – Secured Overnight Financing Rate (SOFR)
   3. What are others doing and is there any consistency?
   4. Some key challenges of starting with overnight rates as benchmarks.
   5. Europe – EURIBOR, EUR-LIBOR, EONIA, EURONIA, and now a new ECB overnight rate?
   6. EONIA reform – following the path the BoE is taking, towards a EURIBOR replacement?
   7. How big is the challenge of replacing EURIBOR and EONIA?
   8. So where does that leave the EURIBOR replacement?
3. Part 3 – The Consequences
   1. Will LIBOR reform look like “Y2k for the legal profession?”
   2. What happens if nothing happens?
   3. Summary of the issues and problems so far.
      1. Premature disorderly collapse
      2. No clear alternative benchmark
      3. Term premium
      4. Credit Premium
      5. The legal costs of replacing LIBOR
      6. Reaching agreement on language for converting to the new benchmark
   4. Could the Libor reform trigger a financial crisis ?
4. Part 4 – the Impact

1. 1. 1. Markets impacted by the retirement of LIBOR.
         1. The swaps market
         2. The LIBOR-based short rate exchange-traded derivatives
         3. Foreign exchange (FX) markets
         4. Cross-currency basis market
         5. Liability Driven Investment (LDI)
         6. The US loan and securitization markets
         7. Sterling LIBOR
         8. Yen LIBOR
         9. Swiss reforms
      2.  A comment on the current differences of opinion between market participants

References and Appendices

1. References
2. Appendix 1 – Documentation examples for US$ LIBOR and EURIBOR
3. Appendix 2 – LIBOR footprints across the five LIBOR currency regimes