The London Inter Bank Offered Rate will no longer be supported from the end of this year, after a four-and-a-half-year transition that affects multiple markets. Do trustees need to discuss the change with their managers? 

 

The end of this year will also be the end of LIBOR. After a major rigging scandal around 10 years ago and a fall in its use, the Financial Conduct Authority said in 2017 that it would start phasing the benchmark out, and no longer support it from the end of this year.  

 

In the UK, the short-term lending rate is set to be replaced by the Sterling Overnight Index Average. The FCA and Bank of England are keen to see a smooth transition from LIBOR, which is used predominantly for derivatives. 

 

Last week, Edwin Schooling Latter, director markets and wholesale policy at the FCA, in a speech at City & Financial described the sheer volume of assets affected, saying reports have referred to several hundred trillion dollars in LIBOR-referencing contracts. “Our current estimate is US$260 trillion,” he said. 

 

About 80% of this is accounted for by cleared interest rate swaps and exchange-traded derivatives. However, cleared swaps will in effect have “the same triggers and fallback arrangements as in the [International Swaps and Derivatives Association] protocol. So in economic terms, they will become [risk-free rate]-based contracts from the point LIBOR ceases or becomes unrepresentative”, he noted. 

 

The challenges in managing other LIBOR-linked contracts should however not be underestimated, and affect bond, securitisation, loan and mortgage markets. In some existing contracts, it could make more sense to continue to use LIBOR; the FCA is therefore considering publishing synthetic LIBOR, said Schooling Latter. 

 

“Where we do envisage requiring continued publication of a LIBOR setting on a synthetic basis, this will be subject to a further consultation and decision on the specific settings,” he explained. 

 

If the administrator of LIBOR confirms it wants to bring the relevant currency panel to a stop at end-2021, “we would want to launch such consultations in a timely way so as to minimise unnecessary uncertainty”, he said. This means that such consultations could be the next step, and decisions could be made once the new powers are on the statute book, potentially in summer 2021, to give markets clarity as early as possible, he added. 

 

“But a key point to understand is that synthetic LIBOR is not for use in new contracts. It is intended to help the problem of genuine tough legacy contracts,” he said. 

 

In the UK, the financial services bill proposes to give the FCA powers to restrict the use of a critical benchmark when it is known that it is going to cease; it also proposes powers for the FCA to define which legacy contracts will be allowed to use synthetic LIBOR. 

 

“So, expect consultation proposals from us in the spring on a framework for using both powers," he said, adding: “In terms of what legacy use of synthetic LIBOR to allow in the UK, we will need to strike a careful balance in terms of where this is necessary and desirable.” 

 

 

Pension fund trustees might not need to worry too much, though, some have said. “I do not think the change from LIBOR to SONIA is an issue for most trustees,” said Brendan McLean, an investment researcher at Dalriada Trustees. 

 

Managers have or will change their absolute return benchmark to SONIA. “Since LIBOR is similar to SONIA, it will not materially change the relative performance,” he said; and although LDI managers could be impacted more, they have been preparing for the change for several years. 

 

“It could be an issue for trustees if they have a small manager that does not have the resource to handle the change; however, trustees should not be invested with such managers,” he added. 

 

But others advise that trustees need to review aspects of their scheme’s investment arrangements which have LIBOR exposure, to ensure there is a plan in place to implement the transition smoothly. 

 

Parth Purohit, a portfolio manager at SECOR Asset Management, said investors should measure their overall IBOR-based instruments and determine any key risks to the plan, such as impact to hedge ratio, performance, tax and regulatory reporting due to the transition. 

 

While the mark-to-market and risk impact to derivatives and newer issued debt may be limited, “old vintage debt with no flexible fallback language should be amended”, he said. 

 

When it comes to investment manager agreements, trustees should ensure that any references to IBOR in benchmarks or performance fee calculations have been either renegotiated or updated to include an IBOR cessation fallback, he said. 

 

Trustees should confirm that manager trading systems and models have been upgraded to seamlessly manage legacy and alternative rate based trades in the portfolio, he said. 

 

Purohit recommended that trustees engage in discussions with each manager to ensure they are making preparations aligned with industry best practice. In addition, funds should “ask managers to potentially minimise purchasing any new holdings in the portfolio without appropriate fallback language”, he said.