Keep Calm and Transition On...

Updated: Apr 23, 2020

The COVID-19 virus has led to several key financial regulations being pushed back until later in the year or even deferred by a year. LIBOR transition to the new ARRs (Alternative Reference Rates) is still timetabled for the end of 2021 despite concerns across the industry. Will this major market reform also be delayed or is it a case of keep calm and transition on!

The Securities Financing Transaction Regulation (SFTR) reporting obligation was imminently due to go live on the 13th April 2020 and many banks had been working frantically to meet the deadline. The impact of COVID-19 led this to be delayed until 13th July 2020. This has been one of the many regulations to be delayed. The Uncleared Margin Requirement (UMR) has had a one-year deferral of the September 2020 and September 2021 phase-ins of the global initial margin requirements for non-centrally cleared derivatives. Basel III has had is implementation deferred to 1st Jan 2023 with changes including FRTB (Fundamental Review of the Trading Book) and revised CVA charges deferred by 1 year.

On 25th March 2020 the FCA, Bank of England and members of the working group on Sterling Risk-Free Rates discussed the impact of the COVID-19 on firms transitioning plans over the coming months:

Whilst they have been firm with this message they have given the caveat that some of the interim milestones might move and that they “continue to monitor and assess the impact on transition timelines, and will update the market as soon as possible”, especially with respect to milestones for cash products. On 2nd March 2020 market markers of GBP swaps were asked to switch from GBP LIBOR to SONIA and this has seen SONIA (already well established having been around since 1997) propelled further into the spotlight. The Sterling Risk-Free Rate Working Group (RFRWG) has asked institutions to cease issuance of all cash products, with a maturity beyond 2021, by the end of Q3 2020 and this deadline may well see some slippage.

What are the other key dates? The market has been sluggish to adopt SOFR and I believe the tipping point for liquidity improving and adoption of SOFR replacing USD LIBOR will be when the discounting and PAI (Price Alignment Interest) change at the exchanges. The discounting switch at LCH/Eurex from Eonia for €STR was due to be on the 22nd June 2020 but has now been extended by 5 weeks to the 27th July 2020. This switch is a fixed rate as EONIA = €STR + 8.5bps so technically will be easier to implement. The switch from Fed Funds to SOFR at LCH is due on the 17th of October (with the CME switching a day earlier on the 16th of October). Given the extension to the €STR switch this may well see an extension also. This is a floating switch and if there is a time delay between switching of cleared and non-cleared positions then the basis may move and create valuation inconsistencies between comparable swaps. Regardless of the technical issues, clients will also need to be notified of the changes. Even with short extensions this does not allow much time!

With the lock down from COVID-19 and the move to everyone working from home, it has really been a case of focusing on Run the Bank rather than Change the Bank. Trader/Sales and support staff have all been working from home so it is hard to test changes to any internal systems, bid/offer spreads have been all over the place and many banks have IT freezes in place. The market has really been focusing on trying to ensure enough liquidity rather than any focus on transition.

This has led to a slowdown in the development of ARRs and one of the first key milestones for SOFR to get extended is the deadline for federal home loan banks i.e. Fannie Mae and Freddie Mac to cease LIBOR related loans that mature after the end of 2021. Originally set for the 31st of March this has now been pushed out by three months.

I think the argument against pushing the end of the 2021 deadline out further is that it may keep getting pushed out and then never end up happening. I think that the transition will happen, but the timeline will be different for different currencies and indeed different products i.e. Loans. There will certainly be greater flexibility around the interim milestones (for example with SONIA) and these are likely to be extended. Chris Heeringa, Partner at Dantum Consulting commented "As tough as it is - a lock-down of 2-3 months is actually quite little time if you consider the FCA announced the end of LIBOR in July 2017. In fact, the lock-down has really been in place for about a month. The industry has had plenty of time but has been slow to respond. There are still 20 months to go. Delaying the whole thing now because of people working from home for a couple of weeks and turmoil in the market would seem excessive".

"Keep Calm and Carry On" originally came from a motivational poster produced in 1939 by the British Government in preparation for World War 2 and to bolster morale during air raids. With empty supermarket shelves and draconian lock-down measures in place across most of the world you can see the parallels of this war against a virus. Let’s hope this all ends soon and some normality can return to the market and the transition away from LIBOR can resume in earnest. In the meantime, Stay Safe!

By Tom Hicks, Partner Dantum Consulting

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