Negotiating contracts to replace Libor as a reference benchmark in derivatives could see asset management firms come out of 2021 “more robust than ever” if they get it right, a benchmark expert said.
Firms could use the scrapping of the discredited London Inter-Bank Offered Rate in 2021 to drive “standardisation in fall-back language and contracts” with counterparties, Christian Bahr, of Swiss stock exchange operator SIX Group, told Funds Europe.
But he warned of repercussions for the whole industry if the changeover is not managed correctly.
Bahr’s comments come after a law firm and compliance firm recently warned that asset managers were delaying the negotiating of contracts to replace LIBOR in financial instruments, which could lead to a bottleneck in legal work when the deadline looms.
Bahr, who is head of index and iNAV services at SIX Group, reflected these sentiments, saying few institutions were accounting for new benchmarks coming into usage and that there were no concrete preparations being made.
By December last year, the Bank of England and the Financial Conduct Authority had asked large banks and insurers to submit plans.
“Fund managers were excluded from last December’s industry obligation to submit a Libor transition plan to the regulator,” said Bahr. “Far from preparation being less necessary for fund managers, the impending monumental shift away from Libor will affect all facets of this subset of businesses.”
Bahr said that fund managers need to figure out if they have derivative contracts with exposure to Libor and other reference rates that they want to migrate over to the new rates. He added that while certain contracts with minimal exposure won’t be affected, there may be larger exposures that need to have some form of a safety net built into them.
“If multiple counterparties are involved in a big transaction, fund managers face a number of difficult conversations about switching derivative contracts from one rate to another. However, if they don’t broach this issue now, they risk contracts becoming unviable.”
It could also be that all banks proving financial products or currency hedges will adjust their services and even reduce their offerings, said Bahr.
“At the same time, there are potential opportunities for fund managers within the Libor switchover, including driving standardisation in fall-back language and contracts. If fund managers are able to switchover as soon as possible and with minimum fall out, they could come out the other side of 2021 more robust than ever. If not, it could have repercussions for the entire industry.”
In a speech in June 2018, Andrew Bailey, the chief executive of the Financial Conduct Authority, said there were a number of reasons why Libor had to be replaced, not just the manipulation by traders, which he said no longer occurred. One of them is that LIBOR – the London Interbank Offered Rate – is no longer measuring the rate at which banks lend to each other, he said, as banks have retreated from the interbank market.
Proposed alternatives to Libor have been SOFR, SONIA, TONA and in Switzerland SARON for contracts in Swiss francs.
Juan Diego Martin, chief operating officer at Fonetic, a regulatory technology firm, said: “The reform of Libor goes beyond inter-bank lending. There are currently trillions of pounds worth of interest rate swaps and worryingly, retail mortgages, still tied to Libor. The trouble is that these swaps account for a decent proportion of an investment manager’s portfolio. The fund management community, therefore, has vested interest in how the switchover from Libor to SONIA plays out.”
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