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Update for all investors
The cessation of LIBOR rates; GBP, EUR, JPY and CHF occurred on 31st December 2021. The cessation of USD LIBOR is expected to occur at the end of June 2023. LGIM has been helping clients and preparing funds for the transition to alternative risk free rates across currencies for some time and has managed to successfully navigate our business through the market transition effected in December 2021 with a shift in focus now on the USD market transition.
An international initiative was launched to reform interbank offered rates (“IBORs”) and to develop more robust alternatives in 2017. This move was prompted by the widely publicised LIBOR manipulation scandal. IBORs were important because they were frequently used as a benchmark or target return for many funds, as well as underpinning various financial instruments and products and potentially other non-financial contractual arrangements.
Regulators around the world have been engaging with market participants, including banks and asset managers, to consider how best to transition to new alternative risk free rates (“RFRs”). Legal & General participated in various market work streams led by the Bank of England to help all aspects of the transition away from IBORs.
The transition has represented a significant market challenge, particularly for banks, asset managers and financial services firms across the industry. Estimates of the amount of IBOR-related activity in the banking and financial sector vary, but all pointed to global exposures in the hundreds of trillions. A significant amount of work has been required by all market participants to ensure a smooth transition.
Transition from LIBOR | FCA (link is external)
What happened?
As of the respective rate cessation dates, panel banks are no longer compelled to submit quotes to determine the London Inter Bank Offer Rate (LIBOR), effectively discontinuing the rate. As a consequence, substantial shifts in global trading and transition activity to alternative RFRs has been taking place.
This has very much been a market-led transition that has depended heavily on the developments of market participants, which have been enabled by numerous industry groups. LGIM has monitored these developments closely and taken action where appropriate in the interest of our clients. The UK has been the global leader in transition progress. The widely accepted GBP LIBOR fall-back is the alternative RFR, SONIA, which has been well developed in the derivatives market since its reform in April 2018, and subsequently developed across cash and loans markets.
However there have been some contractual dependencies that have proved harder to transition and as a result the FCA was granted powers which allow them to mandate the use of a ‘synthetic’ LIBOR rate in the market under certain circumstances, e.g. where contracts cannot be updated to refer to an alternative RFR. Such contracts are referred to as ‘Tough legacy’.
The FCA confirmed on the 1st January 2022 that the publication of 24 LIBOR settings has ended, and the 6 most widely used sterling and Japanese yen settings will be published using a changed methodology for use in a limited range of circumstances.
The LIBOR settings that have ended are:
- all euro and Swiss franc LIBOR settings
- the overnight / spot next, 1-week, 2-month and 12-month sterling and Japanese yen LIBOR settings
- the 1-week and 2-month US dollar LIBOR settings
The ‘synthetic’ LIBOR rates are;
- 1-month, 3-month and 6-month sterling LIBOR versions
- 1-month, 3-month and 6-month Japanese yen LIBOR versions
‘Synthetic’ LIBOR does not depend on quotes from panel banks and is not permitted to be used in new contracts as of January 2022. It should only be used to support existing references excluding cleared derivatives and is not intended as a substitute for active transition where transition to RFRs or ‘fallbacks’ is available.
The FCA will review the publication and use of ‘synthetic’ LIBOR again at the end of 2022.
USD LIBOR Transition
Progress is also being made across the pond with the US Transition body ARRC, who are also taking similar steps previously taken in the UK to promote the Secured Overnight Financing Rate (SOFR) as the new RFR to USD LIBOR. This is positive for the Global transition effort and will ensure the market is fully prepared to meet its obligations in 2023.
ARRC_Press_Release_Term_SOFR.pdf (newyorkfed.org)
How will it affect your investments with us?
LGIM has identified and addressed our clients’ investment exposure to IBORs in CHF, EUR and GBP with an established governance structure around our transition activity. We have also been working in partnership with our parent company Legal & General Group PLC, who have established thorough and strong governance with a central co-ordination oversight, supported by divisional delivery.
This has allowed us to share project management and legal expertise to ensure an effective and controlled transition pipeline. As the market moves focus towards USD LIBOR transition LGIM along with L&G will continue to support the business needs for transition.
What are the risks?
The FCA has reiterated that market participants should not depend on LIBOR beyond cessation. The transition involves a two-way path: (i) establishing multiple new products, and (ii) changing existing IBOR-referenced products. It also affects products across different jurisdictions which are transitioning to different alternative rates at different times.
Risks are therefore associated with:
- Transfer of economic value when moving IBORs to RFRs
- Operational process changes
- Amending legal agreements
- Liquidity risks of terminating IBOR instruments and replacing these with alternative RFR instruments
LGIM has always supported a transition first approach therefore we have managed to significantly reduce the risks to LIBOR within our business. This has allowed us to efficiently prepare our business for the cessation of LIBOR rates and further mitigate the above risks associated with transition.
Do you need to do anything?
Currently, you do not need to take any action with respect to your investments with LGIM. We will be in touch regarding your investments as appropriate, so please do look out for communications from us on this matter. However, if you are potentially impacted by the transition in other ways, please seek appropriate legal advice and guidance. You can also contact your usual LGIM representative if you would like to discuss this regulatory change and potential impact on your investments in more detail.
Further information can be found here:
https://www.bankofengland.co.uk/markets/transition-to-sterling-risk-free-rates-from-libor (link is external)
What are IBORs?
IBORs (Inter Bank Offer Rates) are financial benchmarks showing the average rates at which major banks can borrow in the interbank market. They are forward-looking, unsecured rates and range from overnight to 12 months.
IBORs also act as reference rates to hundreds of trillions of dollars in notional derivative exposure, for example interest rate swaps, and trillions of dollars in bonds, loans, mortgages, securitisations and deposits across institutional, corporate and retail market participants.
IBORs exist in different currencies. For example, GBP LIBOR is the rate at which UK banks can borrow from one another in sterling, and USD LIBOR is the rate at which banks can borrow from each other in US dollars.
What are the alternatives to IBORs?
Alternative Risk Free Rates (“RFRs”) have been established across the different IBOR jurisdictions. In the UK, the Bank of England recommended that reformed SONIA (Sterling Over Night Index Average) be used as the sterling near risk-free reference rate and has promoted its adoption as an alternative to GBP LIBOR.
Alternative RFRs are intended to be more representative and robust. In addition to the manipulation scandals, the number of transactions underpinning the rates set by IBORs has been declining; as a result of post-financial crisis reforms, banks often now favour secured lending through deposits, repos and bonds. This means that IBORs are no longer a true reflection of the markets they are designed to represent.
What are ‘Fallbacks’ and the ISDA Protocol?
The International Swaps and Derivatives Association (“ISDA”) worked to establish suitable fallback language for IBOR references within trading contracts named The ISDA 2020 IBOR Fallbacks Protocol (“ISDA Protocol”).
ISDA are an organisation who facilitate and set market standards in the trading of financial derivatives, usually traded under ISDA standardised Master Agreements. These instruments were often traded using IBOR rates. Notwithstanding ISDA’s primary role of being a global sounding board for derivatives transactions, given its global reach and influence in financial markets, ISDA has, in certain occasions created industry-wide protocols that have a wider scope than derivatives and ISDA-owned master agreements. With that in mind, in October 2020, ISDA published the ISDA Protocol with the aim to amend the terms of a wide range of market standard trading agreements such as ISDA Master Agreements, Global Master Repurchase Agreements, Global Master Securities Lending Agreements and International Foreign Exchange Master Agreements, to name a few, to ensure that on the permanent cessation of an IBOR or when an IBOR is deemed no longer representative a fallback rate is in place to provide for the continuation of the relevant IBOR linked trade and/or commercial provision.
The fallback rates have been determined via a market consultation and are now published as the selected currency RFR + a spread to ensure minimal value transfer on the removal of each relevant IBOR.
Further information on the Protocol and its expanded scope can be found here:
ISDA 2020 IBOR Fallbacks Protocol – International Swaps and Derivatives Association
LGIM, acting as agent, has adhered to the Protocol and on behalf of Clients that have provided us with consent to do so.
What role is LGIM playing in the transition?
LGIM, along with our parent company Legal & General, have been engaged in the UK market transition at various levels with the Bank of England and other leading industry organisations, including the Investment Association, since 2017. Through these forums and our engagement with our counterparties and clients, we have been able to plan our transition away from IBORs ahead of the December 2021 deadline and continue to monitor developments across markets to ensure our business continues to meet the expectations of our clients in compliance with our regulators.