The global financial industry is rallying in anticipation of the Libor transition which will send shockwaves to the market as the benchmark underpins more than US$350 trillion of mortgages, loans and derivatives around the world.

The demise of the Libor will have an impact on more than 1,459 live structures worth an estimated US$18 billion, featuring the Libor benchmark.  

Regulators have been steering market players toward more robust alternatives since they uncovered that during the global financial crisis a number of banks had been manipulating Libor for profit, which resulted in fines amounting to over US$9 billion against a number of banks.

The UK Financial Conduct Authority (FCA) said in 2017 that banks won’t have to submit the data used to calculate Libor starting in 2021 but there is no clarity as of what will happen in the structured products market, and products linked to Libor continue to be issued today - China’s three-month Libor linked deposits were best-sellers in H1.

Most issuers are on a ‘business as usual’ mode but there are resources and teams being put together to address the transition

All the manufacturers approached including the main providers of Libor linked structured products in the retail market declined to go on the record. However, a senior investment banker in charge of structured products distribution at a European bank, notes that this kind of change “will impact thousands of instruments out there, and will send shockwaves across many functions and businesses within a bank”.

“Most issuers are on a ‘business as usual’ mode but there are resources and teams being put together to address the transition and find solutions for those positions linked to Libor,” he says.

“Within the bank there is currently a working group that is mapping the impact the Euribor/Libor reform will have on all products, contracts etc. Our CMS-linked structured products are also included. However, at this stage it is too early to give a concrete answer as to what will happen to these products after January 1, 2022. We will notify people who have invested in these notes in time if changes are necessary.”

Reference gauge

Libor is a very flexible mechanism and is used specially for short-term measuring of daily cash accrual. Because there’s so much capital under management and there is not a clear alternative there is uncertainty as of what benchmark will replace the Libor.

Most structured products term-sheets include clauses to accommodate underlying changes throughout their lifetime

“The market will need a reference gauge or an accepted generic way to define interest rates, and most structured products term-sheets include clauses to accommodate underlying changes throughout their lifetime,” says Tim Mortimer, managing director at FVC. "Some contracts have more discretion than others, but the market should not be left without a reliable way of calculating interest rates."

While some liquidity has been building up in the newly announced repofund rate (RFR) indices such as the secured overnight financing rate (Sofr) and Sonia, volumes are still behind those of the Libor, says Alexandre Bon, group co-head Libor & benchmark reform at Murex, noting that at this stage “Sonia is probably the most advanced RFR market, since this was not a newly created index like Sofr.”

According to Bon, issuances of new floating rate notes in GBP Libor have stopped and are now all referencing Sonia instead.

“The Sonia swap market also shows some healthy volumes - comparable to GBP Libor swaps volumes in notional terms, although in number of contracts the Libor market is still much more active (smaller non-bank institutions still prefer Libor) and there is less liquidity on maturities beyond five years,” says Bon. “As for cross currency swap or structured products we have seen a single one referencing the new RFRs. So we still need to build liquidity in the swap and cash markets first to get these product segments started.”

Legal advice

Beyond structured products Libor has been a hot topic for law firms over the last six to nine months.

“We have been at the forefront of some of the market-leading transactions to pave the way for Sonia adoption in the Sterling markets,” says Alex Biles, partner at Ashurst. “In addition to that, we also have been mandated to advise several international banks on their strategic Ibor transition projects, which covers a wide range of products from loans to derivatives to capital markets issuances to trade finance.”

With reference to pure legal draft on structured products, the first changes Ashurst has originally dealt with relate to the benchmark regulation (article 28.2) which requires product issuers in Europe to ensure that they have "robust" written plans setting out the actions to be taken in the event that one or more benchmarks materially change or cease to be provided.

“Our first actions in relation to structured products documentation around the Libor transition was putting language into the documentation that met the requirements of article 28.2,” says Michael Logie (pictured), partner and head of global markets (Emea & US)at Ashurst. “Following on from that, we have been updating programme documentation for various banks to allow issuance of new products linked to new near risk-free reference rates, including Sonia and Sofr structures.”

According to Logie, some clients “have been keen to adopt the recommended fall-back language published by the US ARRC – the Alternative Reference Rates Committee”.

“We have been actively incorporating ARRC language into the programme documentation for a number of our US investment banking clients,” says Logie. “We think there are challenges around capital markets and structured products but we think it may be easier to find solutions than the cash equity and loan markets where the end goal is not clearly underlined.”

Yesterday (November 21) the UK regulator urged banks to end Libor-based swaps and switch to Sonia swaps early next year.