RESOLVING TRANSITION’S KEY ISSUES · No new LIBOR business loans, securities and derivatives....
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RESOLVING TRANSITION’S KEY ISSUES September 10th, 2020 10 AM, US Eastern Daylight Time
Transcript of RESOLVING TRANSITION’S KEY ISSUES · No new LIBOR business loans, securities and derivatives....
RESOLVING TRANSITION’S KEY ISSUESSeptember 10th, 202010 AM, US Eastern Daylight Time
3© Oliver Wyman
Dan RosenbaumPartner, Core LIBOR Platform [email protected]
Adam SchneiderPartner, Lead LIBOR [email protected]
OLIVER WYMAN HOSTS
Ming LeePartner, Core LIBOR [email protected]
Esther BrueggerPrincipal, Lead LIBOR Analytics [email protected]
4© Oliver Wyman
RESOLVING TRANSITION’S KEY ISSUES – AGENDA
1 Introductions & Opening Remarks Dan Rosenbaum
2 Accelerating Your Program for 2021 Adam Schneider
3 Should You Accept the ISDA Fallback? Esther Bruegger
4 Taking the Last Lap: What Are the Key Open Issues? Ming Min Lee
5 Q&A and Closing Remarks Dan Rosenbaum
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USD LIBOR market footprint by asset class1
Volume ($ BN) % LIBOR Target Rate* Target Date
Loans
Syndicated loans2 3,400 95% SOFR in arrears June 2021
Corporate business loans2 1,650 30–50% SOFR in arrears June 2021Noncorporate business loans 1,250 30–50% SOFR in arrears June 2021CRE/Commercial mortgages 3,600 30–50% SOFR in arrears June 2021Retail mortgages 9,600 15% SOFR in advance Sept 2020Consumer loans 1,800 Low N/A N/AStudent loans 1,150 5% SOFR in advance TBD
Bonds Floating/Variable rate notes 1,500 85% SOFR in arrears Dec 2020
Securitization
Residential mortgage-backed securities 7,500 25% SOFR in arrears
or term June 2021
Commercial mortgage-backed securities 650 5% SOFR in arrears June 2021
Asset-backed securities 1,400 40% SOFR in arrears June 2021Collateralized loan obligations 300 70% SOFR in arrears Sept 2021
Over-the-counter derivatives
Interest rate swaps / forwards / options 171,200 65% SOFR in arrears June 2021
ETDs Interest rate options / futures 28,900 95% SOFR in arrears June 2021
ARRC target to “sunset” new issuance
Cash products
Derivatives
= Large cash product exposure * SOFR in arrears is generally recommended by ARRC. Consumer products generally will use SOFR in advance. Other rates may gain favor as well as the market is still evolving. Many products may move to term SOFR if and when available.
THE ARRC HAS STATED A GOAL OF ENDING NEW LIBOR ISSUANCE IN MID-2021; BY THEN FIRMS NEED TO TRANSACT IN ALTERNATE RATES
1. Estimated based on prior industry and Federal Reserve surveys, Oliver Wyman analysis2. Some overlap exists between estimates of syndicated and corporate business loans
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Market development
2020 2021POST-LIBOR
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
End of MarchNo new LIBOR cash Iending
January 2022Expected LIBOR discontinuation
SeptemberPublication of SONIA term rate
Mid-2021Stock of LIBOR contracts significantly reduced
All currencies
USD
GBP
Q3ISDA protocol published
Before end 2020ISDA protocol target for adoption
Regulatory milestone
Target date for ceasing most LIBOR issuance
October 19CCPs switch to SOFR discounting/ PAI
Q4 (or before)SOFR term rate to be published
Q2CCPs no longer accept new swaps with EFFR discounting / PAI
End of 2020Fannie Mae and Freddie Mac to stop accepting LIBOR mortgages
June 30FHLBs cease entering into new long-dated LIBOR instruments
Before End 2020No new LIBOR FRNs and consumer mortgages
Q2-Q3 2021No new LIBOR business loans, securities and derivatives
ARRC Recommended Deadline
WITH NUMEROUS MILESTONES OVER THE NEXT FEW MONTHS PROGRAMS MUST TAKE STOCK AND IF NEED BE ACCELERATE
(Estimated)UK synthetic LIBOR issue resolved
(Estimated)EU use of tough legacy powers and U.S. use of synthetic LIBOR resolved
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AProgram Strategy
and Management`
Program Setup Complete
Workstream Plans Well defined workplans being executed
Program Management
Well defined program management, decisioning, industry/regulatory engagement, exposure monitoring, and communications
Supporting regulatory response Automated exposure monitoring
BBusiness
Mobilization
Back Book Remediation and Customer Engagement
Extraction of terms completed Analysis to quantify transition paths and selection of strategy complete Plan for client outreach developed Amendment and repapering underway
New Products
Analysis of ARR financial implications Developed pricing strategy (ARR, pricing methodology, spread, floors…) Simulated ARR products versus LIBOR products Required product approvals, technology “ready to go” or scheduled Customer materials “ready to go”
Technology and Operations
Executing technology implementation for ARRs Ready to go for managing contract / repapering with customers Thinking about fallback execution and planning later this year
Legal and Advisory Term extraction complete Amendment and repapering underway Improved fallback language in use
WHAT DOES GREEN LOOK LIKE BY THE END OF 2020? (1/2)
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CAdministrative Mobilization
Risk Management Operational, financial risks understood Risk embedded into transition review and challenge Timelines, progress routinely monitored
Models
Relevant models identified Ongoing remediation of models critically dependent on
LIBOR – especially interest rate risk / market risk / forecasting models
Stress test models under review
Bank/Business Operations
Banks: evaluating implications on funding, hedging, FTP, ALM…
Buy side: evaluating implications for fund prospectus, descriptions, fee arrangements, benchmarks
Other investors: ensuring valuation questions are well understood
DMigration Testing
and Implementation
End-of-LIBOR Support
Understand “end of LIBOR” communications program Understand fallback communications and how
positions will be modified Developing execution plan / playbooks for testing of
fallbacks and new product implementation
WHAT DOES GREEN LOOK LIKE BY THE END OF 2020? (2/2)
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ACCELERATING YOUR PROGRAM
Key learnings from across the industry
SITUATION THOUGHTS
• Frantic LIBOR Transition Office, Not-So-Frantic Businesses
• Emphasize timeline and regulatory asks• Engage top-of-house• Critically grade workplans
• Program funding not sufficient • Engage top-of-house / regulatory response process
• Technology is far behind • Have a plan and resource up• Push on vendors / internal providers• Prepare for manual fallbacks / products (sorry)
• “Where are my peers”? • G-SIBs and $T asset managers will be ready. • Don’t fall behind.
• Haven’t looked at financial implications of fallbacks
• If on balance sheet (255?) – potentially large.• Get a study going ASAP
• Don’t yet understand implications of ARR products
• Get a study going ASAP. A wide variety of ARR products are coming that all work differently
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POLL: WHERE DO YOU EXPECT YOUR FIRM TO BE AT END OF YEAR 2020?
PollWhat will your firm’s LIBOR transition status
be at the end of 2020?GreenYellow
Red Infrared
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THE TIMELINE FOR THE ISDA PROTOCOL FOR LEGACY NON-CLEARED DERIVATIVES HAS BEEN CONTINUOUSLY PUSHED BACK
ISDA BOARD STATEMENT ON ADHERENCE TO THE IBOR FALLBACK PROTOCOL
July 29th, 2020
As part of its work, ISDA will soon publish the IBOR Fallback Protocol to facilitate inclusion of the new fallbacks in existing non-cleared IBOR derivatives transactions between counterparties that both adhere to the protocol
• Amendment to 2006 ISDA Definitions to include fallbacks that would apply upon:– Permanent discontinuation of LIBOR and other key IBORs – A non-representative determination for LIBOR
• Fallback terms to be implemented replace LIBOR with SOFR plus a historical median spread between LIBOR and SOFR
• Amendment to 2006 ISDA Definitions will apply to all new transactions after it takes effecthttps://www.isda.org/2020/07/29/isda-board-statement-on-adherence-to-the-ibor-fallback-protocol/#:~:text=The%20IBOR%20Fallback%20Protocol%20is,risks%20associated%20with%20the%20expected
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HOW MIGHT THE ISDA PROTOCOL AFFECT YOUR FIRM?
Key considerations
Fallbacks
• ISDA’s new fallback language will be applied to existing derivatives transactions between adherents
• Protects adherents from risk of disruption should LIBOR become unavailable
Escrow
• Institutions can sign up to adhere to the Protocol “in escrow” before the official launch
• This will consist of a two-week pre-publication period in which firms can sign up to adhere to the protocol
Timeline
• It is expected that the escrow period will begin soon• Protocol launch and associated amendments to 2006 ISDA
definitions expected this month• Amendments and related protocol expected to be effective late
2020 (or 3-4 months after publication)
https://www.isda.org/2020/05/11/benchmark-reform-and-transition-from-libor/
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THE ARRC HAS RECOMMENDED AND ENCOURAGED ADHERENCE TO THE ISDA FALLBACK PROTOCOL
RE: PREPARING TO ADHERE TO ISDA’S PROTOCOLTO: ALL ARRC MEMBERS
August 10th, 2020
Widespread adherence to the IBOR Fallback Protocol is a vital step in the transition to more robust reference rates, and is essential to addressing both individual firm risks and systemic risks associated with the discontinuation of LIBOR
• ARRC Chair Tom Wipf has recommended that every ARRC member be prepared to sign onto the Protocol
• ARRC has updated Best Practices to include adherence to ISDA protocol “in escrow” by dealers and other firms with significant derivatives exposures; urges that other market participants adhere to Protocol “within the 3 to 4 month period after it is published and before the amendments to embed the fallbacks in legacy transactions take effect”
https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC_Letter_on_ISDA_Protocol.pdf
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WHAT ARE THE IMPLICATIONS OF ISDA PROTOCOL ADHERENCE (OR LACK THEREOF)?
Both counterparties to a transaction adhere
• Next steps are clear and transparent• Operationally smooth• Market seems to be pricing in adherence
(see following pages)
Only one or neither counterparty to a transaction adheres
• Valuation, quotation, and margin calling will be very complex and highly uncertain
• Potential for controversy: for instance, calculation agent to use ISDA fallback, counterparty to dispute and argue for more favorable quote
Derivatives not governed by ISDA master service agreements
• Dealers must be ready for and aware of this book of work
• Bilateral renegotiations of fallback terms likely
Transactions governed by ISDA Master Agreements
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SHOULD YOU ADHERE TO THE ISDA PROTOCOL?
Safeguards consistency
• Ensures that derivatives contracts continue to reference clear, transparent, and consistent rates
• Continued functioning market in legacy IBOR contracts
Reduces institutional resource requirements
• Prevents market participants from having to remediate significant back-book derivatives exposures one by one
• Firms can shift resources to other LIBOR transition activities
Mitigates risk
• Critical to fortifying existing derivatives contracts with durable and improved fallback language
• Minimizes conduct risk and reduces likelihood of litigation
Advantages of adhering: Considerations associated with not adhering:
Potential value gain
• Provides a potential opportunity to negotiate more favorable terms
• Precludes having to make an early financial decision and allows rate environment to play out
PollWill your firm adhere to the
ISDA Protocol?
Yes
No
Have not decided
By fund or by entity
18© 2020 Oliver Wyman and Bloomberg
BLOOMBERG AND OW HAVE COLLABORATED ON A BENCHMARKING STUDY TO SHOWCASE REQUIRED VALUATION APPROACHES
Stylized swap portfolio• Vanilla swaps portfolio in USD and Euro
• Out-of-the-money and at-the-money
• Fixed/floating as well as forward swaps
• Maturities up to 30 years
Transition scenarios• Different timing of LIBOR cessation; every
quarter from 12/31/2021 to 12/29/2023
• Different rate scenarios, e.g., scenarios based on evolution to the forward rates and shocks to the forward curve
Calculation methodologies leveraging Bloomberg MARS Portfolio Risk Engine
Fallback impact on valuation
Discount rate change impact
Initial Margin impact for cleared & uncleared swaps
and derivatives benchmarking study
19© 2020 Oliver Wyman and Bloomberg
EXAMPLE RESULT FROM BLOOMBERG-OW STUDY: LIBOR FORWARD RATES NOW PRICE IN ISDA FALLBACK TERMS WITH A HIGH PROBABILITYFallback impact on USD swap market value (as of August 1, 2020)Shown as change in market value divided by DV01
Key takeaways
• Longer maturity swaps affected more
• Delayed cessation increases impact
• Almost all impact incorporated for 12/2021
0.33
2.40
1.65
4.04
3.19
5.64
2.97
5.37
LIBOR cessation in December 2021 LIBOR cessation in June 2022
5Y LIBOR Swap10Y LIBOR Swap10x10Y LIBOR Swap30Y LIBOR Swap
Source: and Oliver Wyman LIBOR transition derivatives benchmarking study, August 1, 2020
What is fallback impact?
• Fallback valuation determined according to difference between standard valuation (LIBOR forward rates) and valuation that incorporates ISDA fallback (SOFR + spread adjustment) after cessation date
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Understand and finalize your choices for the ISDA Fallback Protocol
Be prepared to implement ISDA fallback terms in systems and operational capabilities
Develop valuation approach for legacy transactions with non-adhering counterparties
Assess and keep track of exposure to non-adhering counterparties
Plan for bilateral negotiations with non-adhering counterparties
Consider risk limits around trading with non-adhering counterparties
KEY TAKEAWAYS
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01 02 03 04 05SOFR Lending
• When will SOFR lending start?
• Is a term rate needed?
• Will other rates emerge as lending rates?
Credit Sensitivity
• Will a credit spread be added?
Value Transfer
• Do you need to understand the value implications of fallbacks?
• Do you understand the value implications of new base rates?
Synthetic LIBOR
• Will there be synthetic LIBOR?
• Can you use it in the U.K.?
• Can you use it in the E.U.?
• Can you use it in the U.S.?
Fallback Execution
• Will fallbacks execute or be obsolete?
• How will you negotiate with customers?
• Will a legislative fix occur?
KEY OPEN ISSUES IN LIBOR TRANSITION
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It is unclear when the market will be using SOFR lending. Other ARRs are also being considered by firms.
• Many firms are targeting Q1 2021 to begin SOFR lending
• SOFR term rates would speed the process
• SOFR in arrears and in advance lending both likely to be important to the market
• Leaders will likely begin SOFR lending no later than Q1 2021 as clients understand LIBOR will really end that year
• All firms will need to offer SOFR products later in 2021
• The market will not consistently move to one rate and a much wider range of rates will be used
Issue Discussion Our Take
WHEN WILL SOFR LENDING START?
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Many banks have expressed an interest in a ‘lending rate’ that is sensitive to bank funding conditions. However, SOFR does not rise with banks’ cost of funds in times of stress.
• Vendors are coming up with credit sensitive rates such as AMERIBOR, ICE Bank Yield Index, Markit, …
• The Fed Credit Sensitivity Group is exploring options
• Banks are eager to try other ideas: premium spread add-ons, dynamic spreads, and fee levies
• Customers are less eager
• Firms need to be prepared for a multi-rate environment, in which SOFR, credit sensitive rates, and SOFR + credit spread adjustment are all simultaneously used
• Given tight time frames, any credit spread will likely not be workable before LIBOR is discontinued
Issue Discussion Our Take
WILL A CREDIT SPREAD BE ADDED?
https://www.risk.net/derivatives/7634206/sofr-and-credit-spread-not-as-simple-as-it-seems
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All fallbacks can result in significant value transfer.Example: A $10 million loan to client XYZ, due Jun 26, 2026 priced @ 3M USD LIBOR + 1.95% with quarterly payments
• Understanding fallbacks and what will happen is a key element of most LIBOR transition programs
• Most firms are not evaluating the financial implications – why not?
• Fallbacks that are not “at the market” are particularly problematic
• Understanding value implications is crucial
• Customer management of contractual obligations vs. conduct risk is also crucial
• Analytical capabilities are mandatory
Issue Discussion Our Take
DO YOU NEED TO UNDERSTAND THE VALUE IMPLICATIONS OF FALLBACKS?
Potential Fallback Clause
Financial impact under forward curve
A $418K
B -$119K
C $-12K
Prime (no spread)
Last available LIBORSOFR, with spread adjustment
Source: LIBORITHMICSTM, a proprietary Oliver Wyman tool
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As part of its expanded powers, the FCA may introduce a “synthetic LIBOR” by directing a methodology change and requiring publication on the same screen as LIBOR currently appears. The U.K., EU, and U.S. all have different regulatory environments that may impact its use.
• Publication of a “synthetic LIBOR” would only occur if:– LIBOR is no longer and
never again will be representative
– Publication is considered necessary to protect consumers or the integrity of the market
• Synthetic LIBOR will exist • It will be used in the U.K. for
tough legacy contracts and may be used in the EU for all legacy contracts during a transitional period
• Synthetic LIBOR is less likely to be used in the U.S., as it conflicts with pending New York State legislation
Issue Discussion Our Take
WILL THE FCA PUBLISH “SYNTHETIC LIBOR?”
https://www.isda.org/2020/06/26/tackling-tough-legacy/
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Many fallbacks are insufficient, as they were created for scenarios in which LIBOR was not published for one or several days, not for its cessation entirely. Synthetic LIBOR and legislative fixes could prevent these insufficient fallbacks from being executed.
• Dependent in part on if synthetic LIBOR exists and is used for tough legacy contracts
• ISDA’s IBOR fallback protocol will apply to legacy uncleared derivatives for all parties that adhere
• ARRC’s New York legislative proposal for benchmark fallback replacement still not enacted
• Many cash product fallbacks will be amended, though some firms have determined that their existing fallbacks are sufficient– These fallbacks will be
executed • ISDA’s protocol, and
potentially ARRC’s legislative proposal, will render many other fallbacks obsolete
Issue Discussion Our Take
WILL FALLBACKS EXECUTE OR BE OBSOLETE?
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POLL: WHICH OF THESE ISSUES IS MOST CONCERNING TO YOUR FIRM?
PollWhich of these issues is most concerning to
your firm?SOFR Lending
Credit SensitivityValue Transfer
Synthetic LIBORFallback Execution
31© Oliver Wyman
CONTACT US
Adam [email protected]
Esther [email protected]
Ming [email protected]
Join us for our October 14th LIBOR Transition Webinar: All About Value Transfer AnalyticsPreliminary Agenda: 1. Budgets and expectations for 2021, 2. CCAR and FTP Valuation /
Models, 3. CCP Discounting, 4. Special Needs for Investment Managers
