The announcement by the International Swaps and Derivatives Association, the Association for Financial Markets in Europe, the International Capital Market Association and the Securities Industry and Financial Markets Association — including its asset management group, Sifma AG — is one of the most public shows yet of co-ordination on benchmark reform across the primary debt and derivatives markets.
Many working groups have been formed in recent years but Thursday’s announcement is one of the most striking examples yet of a collective effort to address the issue of how all markets will move away from interest rates based on interbank offered rates, such as Libor and Euribor.
The move was made in response to Chris Salmon, executive director, markets at the Bank of England, who called in a July 2017 roundtable speech for the widest possible industry engagement with the transition to a new sterling benchmark.
The five trade associations will now undertake a global market survey of infrastructure providers and buy-side and sell-side institutions, and write a detailed report on their use of ibor rates and the issues they foresee in moving away from them.
The roadmap summarises replacement efforts taken so far and key issues to be addressed in ensuring a smooth transition.
These include ensuring liquidity in derivatives markets based on replacement rates, amending existing contracts based on ibor rates, hedging and valuation issues around transitioning legacy contracts, as well as tax, accounting and governance issues.
The report also cites the creation of institutional infrastructures, such as trading and clearing data, as a part of the transition that could cause difficulties. Regulation is also mentioned. The group of five says the move to alternative reference rates could trigger margin requirements on outstanding derivatives contracts.
Since Financial Conduct Authority chief Andrew Bailey’s July 2017 speech announcing the regulator’s 2021 withdrawal from overseeing the calculation of Libor, minds have been concentrated on having credible replacements ready for that deadline.
But for many market participants the sheer size of the task still seems insurmountable by 2021. Using data published by a variety of reference rate working groups and public bodies, the five associations estimate that $370tr of derivatives, loans, securitizations and floating rate bonds reference ibor rates.
Some have called on the banks that submit the data which forms Libor to continue doing so without the FCA’s oversight.
Derivatives players have been ahead of other markets in planning replacement rates. This may not be surprising, since about 80% of the $370tr figure constitutes OTC and exchange-traded derivative contracts.
Working groups in the UK, the US, Switzerland and Japan have all identified risk-free rates to replace their ibor benchmarks.
But none of these is a straight replacement. Not only do they fail to mimic the embedded credit premium of ibor rates — which widen in risk-off markets, while risk-free rates tighten — they also lack a term structure. Recreating the latter is seen as one of the most urgent issues to address on the matter, especially in the syndicated loan market.