The financial industry is about to collectively undergo something that’s never been tried before – the cancelling of a key benchmark that permeates all sectors of the financial market and has historically underpinned trillions of dollars of transactions. No one can say for sure what will happen on January 4 – the first London banking day after 30 LIBOR settings cease or become non-representative – but uncertainty and risk have been minimised to the extent possible by the years of work by the public and private sectors to create a comprehensive framework for transition.
The introduction of robust contractual fallbacks for derivatives is a case in point. Following implementation of the ISDA 2020 IBOR Fallbacks Supplement and protocol earlier this year, a replacement based on risk-free rates (RFRs) will automatically take effect for most of the noncleared derivatives that continue to reference those 30 LIBOR settings at the point of cessation/non-representativeness. These fallbacks effectively provide a safety net to catch those firms that haven’t completed active transition of their legacy LIBOR trades in time, reducing the risk of market disruption that could otherwise occur.
While the fallbacks were not intended to be a primary means of transition, there are indications that more institutions than anticipated plan to rely on them to transfer from LIBOR – an approach that will still require firms to ensure in advance that their systems can cope with the spread-adjusted RFRs used as fallbacks.
While the end is fast approaching for 30 of the LIBOR settings, transition work won’t stop there. Five US dollar LIBOR settings will continue to be published on a representative basis until mid-2023 to allow legacy trades to roll off naturally, although US regulators have made clear that firms should not put on new US dollar LIBOR trades after the end of this year, except in limited circumstances. Fortunately, trading volumes in alternative reference rates have significantly improved in recent months, giving financial institutions viable and liquid alternatives.
This issue of IQ looks at the LIBOR transition from several angles. Along with our cover story that explores what to expect at the end of the year (see pages 12-15), we asked a variety of senior regulators and public-/private-sector working group chairs for their views on next steps (see pages 18-21). The message is consistent: a lot has been achieved, but it isn’t time to rest yet.