C1 Final presentation 04.03.2020 v2 Final... · 05/03/2020 5 0 5 10 15 20 25 30 35 40 Jun 2016 Oct 2016 Jan 2017 May 2017 Sep 2017 Dec 2017 Apr 2018 Aug 2018 Dec 2018 Mar 2019 Jul

05/03/2020

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The countdown to the end of LIBORElizabeth Armitage, Goldman Sachs Nelly Terekhova, Legal and General Investment Management

Wednesday 11 March 2020

Wednesday 11 March 2020 2

Key date

1986How does it work?

What is LIBOR & why is it important?

What’s the problem with LIBOR?

So what is the solution?

05/03/2020

2


What is LIBOR & why is it important?

1 Source: 2014 ISDA

0 20 40 60 80 100 120

US Dollar

Euro

British Pound

Japanese Yen

Swiss Franc

Tibor (Yen)

The Legacy of LIBOR (£tril)1

It's still used to benchmarkover $350 trillion financial

derivatives


How does it work?

0.7000

0.70000.7200

0.7200

0.72500.7300

0.73000.7310

0.7600

0.76000.7750

0.7800

0.79000.8100

0.81000.8400

0.8625

0.9000

0.7000

0.70000.7200

0.7200

0.81000.8400

0.8625

0.9000

Rabobank

JPMorgan Chase

Societe Generale

Royal Bank of Canada

Citigroup

Bank of America

HSBC

UBS

Bank of Tokyo-Mitsubishi

Credit Suisse

Royal Bank of Scotland

Barclays

Sumitomo Mitsui Financial Group

Norinchukin

BNP Paribas

Lloyds

Credit Agricole

Deutsche Bank

For that day, LIBOR = 0.7591

05/03/2020

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What’s the problem with LIBOR?

Relevance Limitations in the relevance of LIBOR as a benchmark rate

Sustainability & Stability

Lack of active and liquid underlying market:• Banks reluctant to lend unsecured overnight• Element of bank credit risk/volatile

LIBOR Manipulation

• LIBOR manipulation in the 2008 financial crisis• 2012 LIBOR scandal


So what is the solution?

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

%

3M £ LIBOR SONIA

1 Data from Bloomberg LLC

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SONIA

0

1

2

3

4

5

6

7

%

3M SONIA 3M LIBOR BoE Base Rate

What is SONIA & reformed SONIA?

Why is it better than LIBOR?

How does it work & how is it measured?


The countdown to the end of LIBOR


Key events –A timeline of historic

events

How big is the problem? How are people transitioning?

Derivatives

Bonds

Loans

The rest of the world

XCCY

Past Present Future

Future timeline

What to watch out for?

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5

0

5

10

15

20

25

30

35

40

Jun 2016 Oct 2016 Jan 2017 May 2017 Sep 2017 Dec 2017 Apr 2018 Aug 2018 Dec 2018 Mar 2019 Jul 2019 Nov 2019 Feb 2020

SO

NIA

vs

3M L

IBO

R S

pre

ad,

Bp

s

Basis narrows as fallbacks calculated from a historical mean, on the event LIBOR is discontinued, implies a

tighter spread

Timeline: Historic events in the LIBOR transition


Market flow drives the basis wider as LDIaccounts transition and hedge funds position

themselves for the transition

Sep 2018: FCA and

PRA issue “Dear CEO

Letter”

Jul 2014: FSB publishes “Reforming Major

Interest Rate Benchmarks” kickstarting creation of working groups to select

alternate risk-free rates (RFRs)

Apr 2017: Reformed SONIA

selected as preferred £ RFR

Jun 2018:First SONIA Floating

Rate Note (FRN) Issued & SONIA

futures begin trading

Nov 2019:Fallbacks announced into

final spread applied to RFRswhen LIBOR ceases to exist

Jul 2017: Andrew Bailey

announced banks will not be required to submit LIBOR after YE 2021

Past Present Future


Feb 2020:The FCA sends “Dear CEO

letter” to asset managers in the UK + ISDA releases a

re-consultation on pre-cessation

Derivatives – How big is the problem?


1 https://www.fsb.org/wp-content/uploads/r_140722b.pdf. Data from 20142 Source: PRA Returns 2015

LIBOR-Linked Derivatives Notional Summary (£bn)2

90.246.3

33.327.527.025.7

24.218.8

8.47.7

6.32.01.81.71.00.50.2

0 20 40 60 80 100

PACAvivaLGAS

Scottish WidowsPIC

PhoenixRLAM

RothesayStandard Life

Friends LifeScottish Equitable

Sun LifePartnership Life

JustLV

Canada LifeZurich

LIBOR-linked Derivatives

= £323bn

Past Present Future

New Hedging

• Bilateral vs Cleared

Backbooks

• Market participants -Legacy positions

• Transition strategies

Loans (1%)

ETD Derivatives

(10%)

OTC Derivatives

(85%)

Securitsation(2%)

Bonds (1%)

Total £26,145bn1

IR Swaps

IR Futures

IR Options

X-Cur. Swaps

IR Options

FRAs

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Derivatives - New Hedging The steady growth of cleared £ LIBOR swaps


Source: https://www.bankofengland.co.uk/bank-overground/2019/how-prepared-are-markets-for-the-end-of-libor1 https://www.fca.org.uk/news/speeches/libor-preparing-end

August 2019

April 2018

Outstanding stock referencing LIBOR

The stock of contracts has increased

Commitment to maintain LIBOR ends

0

5

10

15

20

25

2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

£ T

rill

ion

s

Past Present Future

SONIA accounted for 45% of

notional swaps trading in GBP

in H1 20191

1y 2y 3y 4y 5y 6y 7y 8y 9y 10y 12y 15y 20y 25y 30y 40y 50y12

13

14

15

16

17

18

Ba

sis

cu

rve

-3

M L

IBO

R v

s S

ON

IA

Corporate Treasuries

Hedge Funds

Insurers

Pension Funds

Bank Treasuries

Yield

Tenor: 5y – 20y

Corporate TreasuriesHedge LIBOR / SONIA

risk arising from issuance, or outright

risk vs LIBOR

Hedge Funds Speculative &

structural positioning that benefit from

strong carry

Tenor: 1y – 5y

Bank TreasuriesMortgages,

Deposits, Liquidity buffer asset swaps,

Bond Issuance

Tenor: 20y+

Pension Funds Transact hedging

(ASW buying / Rec Fixed vs LIBOR) in

the 20y+ bucket

Insurers Dispose of assets gained from BPA

activities on ASW vs LIBOR, with profits

Derivatives - Legacy positions


Past Present Future

Half way house

• Some backbook in SONIA• All new trades in SONIA• Good liquidity• Some hit at a future time

SONIA and

LIBOR

• LIBOR liabilities (regulatory)– Have to hold

some capital

Switch from LIBOR to SONIA Exposure

• No hit at a future time• Increasing liquidity

SONIA

• LIBOR liabilities (regulatory)– Have to hold extra

capital for basis risk

Do Nothing • Rely on fallbacks• Diminishing liquidity• No transaction costs

LIBOR• LIBOR liabilities (regulatory)

– No need for extra capital

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7

5

10

15

20

25

30

35

0y 5y 10y 15y 20y 25y 30y 35y 40y 45y 50y

6ML

IBO

R v

s S

ON

IA -

Bp

s

2016 2017 2018 Mar 2020

Derivatives - Fallback Analysis Fallback LIBOR = SONIA + spread

Consultation on the final parameters applicable to RFRs if derivative fallbacks are triggered


Decision was announced 15th November 2019, ISDA expects to implement a historical median spread adjustment over a five-year lookback period

ISDA narrowed the final spread adjustment approach to: 5Y median vs 10Y trimmed mean

Past Present Future


Spread adjustment will likely be the same across IBOR rates

- Minimize risks of distortion in cross-currency hedging

- Avoid creating unnecessary dislocations in the basis market

- Limit regulatory arbitrage across jurisdictions.

2021/2022 Implied Fallback: 17.7/17.8

Bonds – Floating Rate Note debt (FRN)


1 https://www.fsb.org/wp-content/uploads/r_140722b.pdf. Data from 20142 Data from Bloomberg LLC

Past Present Future

Loans (1%)

ETD Derivatives

(10%)

OTC Derivatives

(85%)

Securitsation(2%)

Bonds (1%)

Total £26,145bn1

‘Lag’ mechanism - interest observation period lags the SONIA rate reference

period by 5 London banking days

FiveLondon banking

days

FiveLondon banking

days

Observation period for SONIA

Issue Date/ interest payment date

Interest period

Interest payment date/ maturity date

SONIA observation period vs. interest period

• Q1: SONIA-referencing FRN tranches surpassed LIBOR-referencing ones by volume

• New public issues of £ LIBOR FRNs maturing beyond the end of 2021 have all but ceased

• >£30bn of UK LIBOR FRN debt with maturities beyond 2021.

0255075

100

M J J A S O N D J F M A

2018 2019

%

SONIA LIBOR

FRN issuance 2018-20192

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Bonds – Key Events


H2 2018-H1 2019£20.5bn of SONIA FRNs were issued in H1 2019,

compared with £6.9bn in H2 2018

H2 2018-H1 2019There were 35 new FRN transactions referencing

SONIA in H1, up from 12 in H2 of 2018

April 2019 Securitisation referencing SONIA

Nationwide Building Society issued the first distributed SONIA UK RMBS using SONIA-linked FRN conventions. It also converted its balance sheet to a SONIA-referencing

basis

June 2019Associated British Ports - ABP replaced LIBOR

with compounded SONIA + a fixed spread on £65m FRNs due in 2022.

A meeting of the noteholders on 11 June 2019 passed the extraordinary resolution

June 2018 EIB pioneered the move to SONIA-linked issuance

with a 5 yearFRN

Past Present Future

Loans – Key Events

16

Q3 TargetFCA want to see all new

lending in SONIA not LIBOR

2nd July 2019 NatWest delivers first bilateral SONIA

loan for its corporate customer, National Express Group PLC.

7th August 2019LMA published a guidance note on

credit spread adjustments when moving from LIBOR to SONIA

Past Present Future

Loans (1%)

ETD Derivatives

(10%)

OTC Derivatives

(85%)

Securitsation(2%)

Bonds (1%)

Total £26,145bn1

Wednesday 11 March 2020

1 https://www.fsb.org/wp-content/uploads/r_140722b.pdf. Data from 2014

Term Rates

• Weighted average midpoint of firm bid and offer quotes for listed SONIA products

Compounding

• Entirely in advance of the interest period

• In arrears i.e. 5 day lag mechanism

05/03/2020

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What happens if LIBOR ceases to exist?


Past Present Future

BondsDerivatives Loans

1. ICE Reduced Submissions Policy

– When 4 or fewer complete submissions, ICE re-publishes the previous day’s rate

2. Public statement that LIBOR will cease permanently or indefinitely by,

– The benchmark administrator (ICE)

– A public sector official with authority over the benchmark administrator or the central bank for the relevant currency

3. Statement by the FCA that LIBOR is no longer "representative”

Triggers

Existing Fallbacks

Proposed Fallbacks

Rate from previous period ~ FRN

= fixed rate note

“screen rate”

No fallback language contained in ISDA

documentation

Lender’s

cost of funds

Consent solicitation to amend terms

- Liability management exercises to buy back

bonds

New fallback language market participants can

sign up for via a protocol

LMA Replacement “screen rate” clause

What about the rest of the world? – USD


Past Present Future

1 https://www.oliverwyman.com/content/dam/oliver-wyman/v2/publications/2019/jun/Time-To-Switch-Rates-LIBOR-Transition-FINAL.pdf2 Data from Bloomberg LLC

USD

• SOFR (Secured Overnight Financing Rate) - measure of the cost of borrowing cash overnight collateralized by US Treasury securities

• CME/LCH (clearing houses) started clearing SOFR swaps in 2018

• Trading in SOFR swaps and futures has increased but volumes are still very modest

• Issuance $265bn SOFR vs $811bn LIBOR in 2019.

Asset Estimate of Liquidity1

SOFR SONIA

Swaps

Futures & Forwards

Bonds

Loans

Sufficient liquidity for all activity to take place in RFR market

No liquidity in RFR markets

0

1

2

3

4

5

6

Jul-2018 Jan-2019 Jul-2019 Jan-2020

%

SOFR²

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What about the rest of the world? – EUR


Past Present Future

Source: https://www.clarusft.com/ester-what-you-need-to-know/

EUR

• €STR (Euro Short-Term Rate) published for the first time on 2 Oct 2019

• EIB also printed the market’s first €STR bond

• Reflects wholesale € unsecured overnight borrowing costs of € area banks, based entirely on actual individual transactions.

0

10

20

30

40

50

60

70

80

90

EUR USD GBP

Mil

lio

ns

≤ 2 years 2-5 years 5+ years

Bond Issuance vs OIS – SONIA, EONIA (EUR), SOFR/FF

EUR markets are the only OIS market that see substantial activity longer than 2 years

XCCY – What are the options?

GBP

LIBOR• Current standard for XCCY

swaps• Decommissioned after 2021

SONIA• Reference Benchmark• New standard for GBP swaps• Hasn’t taken off for XCCY

swaps yet due to lack of liquidity in non-LIBOR rates in other currencies

EUR

EURIBOR• Current standard for XCCY

swaps• Will be reformed to become

benchmark-compliant by end 2021

• Transaction volumes have fallen dramatically

EONIA• Reformed to become

ESTR+8.5bps on 2 Oct 2019 until end 2021 to allow the market to change over to ESTR

ESTR• Reference Benchmark• Published from 2 Oct 2019

USD

$ LIBOR• Current standard for XCCY

swaps• Decommissioned after 2021

Fed funds• Target rate for monetary policy• Unsecured overnight rate• Volumes of loans via Fed

Funds are getting lower

SOFR• Reference Benchmark• Secured overnight rate• High transaction volumes• High volatility• Low liquidity so far


Past Present Future

Loans (1%)

ETD Derivatives

(10%)

OTC Derivatives

(85%)

Securitisation (2%)

Bonds (1%)

Total £26,145bn2

X-Cur. Swaps

05/03/2020

11

Timeline: Future events in the LIBOR transition


Past Present Future

1 January 2022Banks no longer compelled by the

FCA to make LIBOR submissions

Q2 2020Agreed upon derivatives fallback language to be

included in updated 2006 ISDA Definitions

Q4 2020Expected clarification

from EIOPA on adoption of new RFRs

within Solvency II

Q3 2020Expected creation

of term SONIA reference rate

Q2-Q4 2021Expected

creation of term SOFR reference

rate

2 Mar 2020Banks to

change market convention for

£ IRS

25 Mar 2020Consultation on How

to Implement Pre-Cessation Fallbacks

closes

30 Apr 2020EIOPA

discussion paper on IBOR

transitions closes

“Some say only two things in life are guaranteed: death and taxes.But I say there are actually three: death, taxes and the end of LIBOR”

John Williams,New York Fed President

The countdown to the end of LIBOR


Will the market make the deadline?

Days Hours Minutes Seconds

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C1 Final presentation 04.03.2020 v2 Final... · 05/03/2020 5 0 5 10 15 20 25 30 35 40 Jun 2016 Oct 2016 Jan 2017 May 2017 Sep 2017 Dec 2017 Apr 2018 Aug 2018 Dec 2018 Mar 2019 Jul