During the last quarter a range of central questions were answered and decisions made. The developments all point to the end of IBORs as we know them. The key topics during the last three months are:
The Euro Euro Working Group, after completing the hearing regarding the new Euro risk-free rate, announced their decision on September 13: ESTER (European short-term rate) should replace the Eonia. With the decision, the market has 15 months to complete the transition, as the Eonia is not compliant with the EU-BMR rules and the 2020 deadline.
Whether the time available for the transition is sufficient is still open. However, the recent developments around SOFR leaves place for some optimism.
The new American benchmark rate SOFR has reached several milestones during the quarter. In July, the LCH accepted SOFR OIS trades for central clearing. Soon after, the first primary markets activities on SOFR basis with issues from different sectors (Fannie Mae, World Bank and Credit Suisse) showed. In addition, CME announced complete SOFR based clearing with discounting and funding based on SOFR. This service is scheduled to be launched in October 2018. With this announcement, the SOFR transition is approximate 18 Months ahead of the original US paced transition plan published in March 2018.
The regulators were also active during the third quarter. On July 12. Three regulators (FCA, FSB and CFTC) and ISDA made coordinated announcements and a publication. The message from the UK FCA was direct:
»I hope it is already clear that the discontinuation of LIBOR should not be considered a remote probability ‘black swan’ event. Firms should treat it is as something that will happen and which they must be prepared for. «
Andrew Bailey, Chief Executive of the FCA
With the “Dear CEO LIBOR letter” from September 19 the UK FCA intensified the tone even further. In the letter, the FCA demanded a written risk analysis and the mitigation plan from every executive board in major UK banks and insurance companies. With this demand, the FCA is requesting that the banks start using resources and money to prepare for the LIBOR cessation.
The only question now is when a similar request will be made to the Euroland banks.
The IBOR Chronicles third Quarter 2018:
July 4. – Working Group on Sterling Risk-Free Reference Rates
The minutes of the May meeting was published. Some good thought and details on the post IBOR world.
July 11. – ESMA
The ESMA made a presentation at the ECON meeting on the EU BMR level 2 (RTS). ESMA is concerned that the level 2 (RTS) legislation has not been approved so far.
»The delayed endorsement of the RTS creates significant uncertainties for all parties involved and risks the proper implementation of the BMR. ESMA therefore asks the Commission to give as soon as possible clarity on the endorsement of the RTS. «
Jakub Michalik, Senior Officer, Corporate Affairs Department of the ESMA
July 12. – ISDA, FCA, CFTC, FSB
All of the four institutions made public statements and even referred to each other.
Consultation on Interbank Offered Rates (IBOR) Fallbacks for 2006 ISDA Definitions
|FCA||Andrew Bailey speech »Interest rate benchmark reform: transition to a world without LIBOR«|
|CFTC||J. Christopher Giancarlo confirms that the end of LIBOR is the objective.
Speech in the Market Risk Advisory Committee
|FSB||Statement regarding the reform of interest rate benchmarks.|
In the speech, Bailey tried to underline the importance of cooperation between the companies concerned.
In addition, Bailey commented the ISDA Fallback consultation:
»Fallback language to support contract continuity or enable conversion of contracts if LIBOR ceases is an essential safety net – a »seat belt« in case of a crash when LIBOR reaches the end of the road.«
Andrew Bailey, Chief Executive of the FCA
The guidance from FCA is clear, to not rely on the fallback rules, but work actively with the IBOR transactions to ensure the transition. The ISDA consultation is open until October 12.
The same day the head of the CFTC in Washington stated:
»The discontinuation of LIBOR is not a possibility. It is a certainty. We must anticipate it, we must accommodate it and we must adapt to it.«
Christopher Giancarlo, chairman of the CFTC
On the same day, the FSB issued a statement on the reform of interest rate benchmarks.
July 17. – LCH accepts the first SOFR OIS Swap for clearing
The first SOFR OIS Swap was accepted for clearing by the LCH. On the same day the CME went even further with the announcement of full SOFR based clearing (discounting and funding) from October 2018.
Even the FED was impressed about the move:
»We are seeing more evidence that SOFR can work for a wide range of products, offering a real alternative to Libor not only for derivatives, but for cash products as well.«
David Bowman, Senior Advisor at the Board of Governors of the Fed, 30. Juli 2018
Juli 25. – Benchmark Administrators and EU BMR
Among the benchmark administrators such as ICE/IBA and EMMI it was quiet. The only news came when the Bank of England published confirmation of SONIA’s compliance with IOSCO principles.
July 26. – Fannie Mae issues first SOFR-based bonds
The lender Fannie Mae has issued the first floating rate bond referencing SOFR. The $6 billion three-part transaction was settled on July 30, 2018. Fanny Mae is also the first bank to publish the corresponding term sheets. These will set the trend for the future.
» We are proud to lead the market in issuing this landmark transaction. With this milestone, our objective is to accelerate the development of the SOFR market and we encourage other issuers in the debt markets to follow. «
Nadine Bates, Senior Vice President and Treasurer of Fannie Mae
July 29. – Working group on Euro risk-free rates
The meeting of the Euro Working Group took place on 11 July in Frankfurt. The agenda included the establishment of a Subgroup 4 with the task of Eonia Transition. The minutes and attachments can be found on the homepage. In addition to the inclusion of Eonia subgroup, there is a note in the minutes that the final decision for the Euro RFR will presumably be taken on 13 September. It says about the further process:
»After the publication of the market feedback on the three candidate RFRs in mid-August 2018, each of the 21 voting members will prepare the vote on behalf of its own institution. The ECB Secretariat will compile the votes, which will remain anonymous to the group. If a decision is reached, the recommended euro RFR will be announced to the working group and published on the ECB’s website simultaneously. Such a decision will ideally be taken at the next working group meeting on 13 September. Consistent with the working group’s terms of reference, a two-thirds majority is requiredfor a working group decision.«
It will be interesting to observe the process, especially because of the requirement of a two-thirds majority.
July 30. – S&P gives green light for investment in SOFR-based issues
The rating agency Standard & Poor’s (S&P) recognises SOFR as a benchmark for floating rate notes so that money market funds are able to invest in them. Due to S&P’s classification as an anchor benchmark, SOFR-based securities are no longer classified as high-risk investments.
»SOFR has an extremely short maturity profile, and given it is expected to replace LIBOR in the coming years, it has gained wide market acceptance with hundreds of billions of dollars’ worth of trading volume since its inception. […] we believe SOFR’s performance in reflective of the movements in short-term money markets.«
S&P’s Global Ratings Division
August 1. – Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks
Renaming of the Study Group on Risk-Free Reference Rate as the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks.
»The deliberations shall also include ensuring the robustness of financial contracts in case the publication of existing interest rate benchmarks such as LIBOR is discontinued permanently, as well as on developing the term structure of RFRs that might be needed for the transition from IBORs to RFRs.«
Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks
August 10. – ESMA
Although Eonia may no longer be used for new business from 2020 according to EU BMR, cash collateral can still be funded with the overnight interest rate. The reason for this is that an Eonia reference in CSAs is not defined as the “use of a reference value” within the meaning of Article 3.1(7)b EU BMR. However, the overnight interest rate will not act as a long-term benchmark, as no stable Eonia curve can exist for discounting due to the lack of new Eonia business.
»Jakobus Feldkamp, senior policy officer for market integrity at the Paris-based European Securities and Markets Authority, tells Risk.net that CSAs will not be dragged into the BMR, which means parties will be free to use the rate in collateral documents covering new and legacy over-the-counter derivatives from the deadline.«
August 13. – Working group on Euro risk-free rates
Publication of the results of the Euro RFR consultation by the Euro Working Group. The summary can be found on the ECB’s homepage. The main message of the financial sector is the following:
»58 respondents or 88% of responses viewed ESTER as the most appropriate future euro risk-free rate, predominantly on the grounds of its unsecured nature, compilation methodology and low volatility, as well as the fact that the ECB – an EU institution – is the administrator. However, several respondents urged that both the start of the regular production and the daily publication time of ESTER be brought forward.«
As we know now, the ESTER was confirmed a month later.
August 14. – World Bank launches first SOFR-based bond
The development bank World Bank is the second issuer to sell a floating rate note referenced to SOFR. The USD 1 billion bond has a maturity of two years and investors come from Europe, North and South America.
»Today’s transaction is an important step in developing robust alternatives to LIBOR, thereby strengthening the global financial system.«
Arunma Oteh, Vice President and Treasurer at the World Bank.
August 20 – Credit Suisse Sells First SOFR-Based Bond
Credit Suisse has sold a USD 100 million SOFR-based certificate of deposit. This makes it the third bank to trade securities linked to the new US interest rate. It is expected that the major bank will issue further SOFR-based bonds in the future and that further issuers will follow.
August 31 – Working Group on Sterling risk-free rate, Minutes of the meeting on August 20. 2018
The minutes of the meeting of 20.8.2018 can be found on the Bank of England homepage. There should be a general interest in the outline from the Subgroup – Market infrastructure. It provides a good overview of the system and infrastructure topics.
September 13. – Working Group on Euro risk-free rates recommends ESTER as successor of Eonia
Around noon on September 13, the Working Group Euro risk-free rate announced that ESTER had been elected as Eonia’s successor. The decision marks the start of the replacement of Eonia. The current schedule foresees that ESTER will start regular operations by the ECB in October 2019 at the latest. This would mean a 12-week parallel phase between ESTER and Eonia, until the non-EU BMR-compliant Eonia can no longer be used for new business from January 2020.
It is likely that the initial schedule will be updated over the next few months.
September 25. – Speech by Benoît Cœuré, Member of the ECB Executive Board
In his speech “Waiting for ESTER: the road ahead for interest rate benchmark reform”, Benoît Cœuré highlights interesting details about both the ESTER as well as the predecessor Eonia.
28. September – Working Group on Euro risk-free rates Minutes of the meeting on Septem-ber 13
In the period since 13 September, most presentations and decisions have largely been published. However, the minutes clearly reveal that the development of Term Rates / Term Structure in particular will pose challenges to the market.