In his address to Bloomberg, London 27 July 2017, about the future of LIBOR, Andrew Bailey, CEO of the British Financial Conduct Authority (FCA), sealed its extinction. “At the end of , it would no longer be necessary for the FCA to persuade, or compel, banks to submit to LIBOR.”
The underlying market for unsecured wholesale term lending to banks, on which LIBOR relies, is not sufficiently active. Rates need to be genuinely representative of market conditions and anchored to transactions, rather than judgements.
With the wind going out of LIBOR’s sails, risk-free rate (RFR) successors, fortunately, are available. Although they will not offer LIBOR’s daily range of seven different maturities (overnight, one week, and 1, 2, 3, 6 and 12 months) in five currencies (US dollar, Euro, British pound, Japanese yen and Swiss franc).
The EU Benchmark Regulation (EU BMR), effective 1 January 2018, introduced new compliance requirements for benchmark administrator, contributors and users. As of 1 January 2020, only EU BMR compliant benchmarks may be used in new contracts.
For the Euro, the ECB in Q4 2018 announced the Euro Short-Term Rate (ESTER) as its RFR, and launched transition consultations. In Spring 2018, the Chicago Mercantile Exchange (CME) started trading in Secured Overnight Financing Rates (SOFR) futures, and the Bank of England started publishing reformed Sterling Overnight Index Average (SONIA) rates. By 2022, new reference rates, including the Swiss SARON and Japanese TONAR, should be in place.
Even though LIBOR is so pervasive and used for so many different purposes in so many different jurisdictions, existing contracts will be subject to a decision by the competent authority of the administrator’s Member State.
LIBOR reform has numerous impacts on the Luxembourgish asset management industry. Product and Fund strategies need to take into account exposure to, and remediation based on reference rate reform. Valuation and Risk Models need to assess economic impacts and define approaches for legacy positions. For performance and benchmarks portfolios there is impact on how calculations are performed. Contract discovery and remediation with industry-wide consistency require changes in legal wording and consideration of fallback positions.
Guidelines and fund documents (KIIDs, Prospectuses, Fact Sheets, etc.) need to assessed for legal impact and updated accordingly. Market liquidity will need to be closely monitored and assessed to effectively time migration to new rates. Market outreach will need to monitor political and regulatory developments, and develop engagement approaches. Ultimately, there is tax impact related to portfolio reallocations and derivative positions, accounting impact due to valuation changes and impact on cash balances related to custodians, collateral managers, brokers, FX hedging, etc.
All that will take time. It requires selecting alternatives to LIBOR, getting documents approved by respective BoDs, communicating to investors, changing contracts with counterparties, updating Risk and Performance, and accounting systems. Luxembourg-based product managers would be wise to position themselves by taking into account the changes in the value change and developing portfolio implementation scenarios.
Luxembourg AWM Leader, Partner, PwC Luxembourg
Tel: +352 49 48 48 3175
Partner, PwC Luxembourg
Tel: +352 49 48 48 2334
Marketing Manager, PwC Luxembourg
Tel: +352 62133 57 21