The International Swaps and Derivatives Association (ISDA), the Association of Financial Markets in Europe (AFME), International Capital Market Association (ICMA) and the Securities Industry and Financial Markets Association (SIFMA) and its asset management group (SIFMA AMG) have published a new report that assesses the issues involved with benchmark reform, and makes recommendations on steps firms can take to prepare for the transition from interbank offered rates (IBORs) to alternative risk-free rates (RFRs).
The report, which was based on a survey of 150 banks, end users, infrastructures and law firms in 24 countries, shows a gap between high levels of awareness of benchmark reform and concrete steps being taken to transition from the IBORs to alternative RFRs.
It also identifies several key issues as being important for a successful and orderly transition, including the need for market participants to develop new cash products and liquidity in derivatives and futures referencing the RFRs. Corporate and financial end users believe a forward-looking term structure for the RFRs is necessary, the report says.
There is an appetite for regular, globally coordinated information from the RFR public/private-sector working groups, as well as further clarity on the preferred end state for each IBOR.
Awareness of benchmark transition issues is relatively high, the survey finds with 87% of respondents concerned about their exposure to the IBORs. Most survey participants expect to adopt RFRs, with 78% stating they intend to trade them within the next four years. The report notes, however, that preparations are at an early stage. While more than half of survey respondents (53%) have commenced internal discussions on the transition to alternative RFRs, a much smaller proportion is at the stage of allocating budget (11%) or developing a preliminary project plan (12%).
Nearly a quarter of all survey participants have not yet initiated a programme to support transition. Some segments of the market – notably corporates – are further behind, with just 30% having started internal discussions within their firms.
Survey participants identified a number of key elements for achieving a successful transition to RFRs. These include wide scale market adoption of the alternative RFRs (cited by 72% of respondents), and the need for market participants to develop liquidity in over-the-counter derivatives and futures referencing the RFRs (64%). Recent progress has been made in this area, the associations say, with the launch of new futures contracts referenced to the reformed UK Sterling Overnight Index Average and the US Secured Overnight Financing Rate (SOFR).
Survey respondents also highlighted valuation and risk management issues (72%). These would primarily apply if market participants opt to amend legacy IBOR transactions to reference alternative RFRs while the relevant IBORs continue to exist.
The absence of forward-looking term fixings was cited as another key issue. The IBORs are currently available in multiple tenors – one, three, six and 12 months – but the RFRs are only available on an overnight basis. Term structures are considered important for certain types of products like floating rate notes, which are traded on the basis of known interest payments at the next interest payment date. Approximately 86% of survey participants believe a forward-looking term structure is required, with corporates and financial end users having the strongest views on the subject.
The ARRC in the US has committed to creating a forward-looking term rate based on derivatives linked to SOFR, while the Working Group on Sterling Risk-Free Reference Rates is expected to launch a consultation on the issue shortly. Other public-/private-sector RFR working groups are also looking at this topic.
The various RFR public/private-sector working groups are recognised as a key source of information on benchmark transition, however, firms expressed a preference for regular, globally coordinated information and more clarity about the desired end state. The need for sufficient time to plan and implement transition was also highlighted, with respondents particularly concerned about compressed timelines in the European Union.
The report also includes a checklist of steps that firms can take to prepare for the transition to alternative RFRs.
“The transition from the IBORs to alternative RFRs will have an impact across financial markets – from derivatives to bonds to mortgages,” says Scott O’Malia, ISDA’s chief executive. “It’s vital that firms commit resources and begin their transition planning initiatives. Our report sets out a number of steps that institutions can take to prepare. Given the scale of the task, this implementation checklist should be adopted now.”
Simon Lewis, AFME chief executive, adds, “This is a timely report. In Europe, there are €1.2 trillion of outstanding securitisations, many of which are linked to an IBOR and will revert to a fixed rate if this IBOR ceases to exist before the maturity of the bond, causing significant changes to future cash flows. To avoid this and ensure that the transition to new risk-free rates is smooth and minimizes disruption for market participants, we need to ensure we are actively engaged with authorities, trade associations and our members to raise awareness and work towards solutions.”
Meanwhile, Martin Scheck, ICMA chief executive, says, “This comprehensive global benchmark survey is an important step forward in raising the level of awareness in international financial markets about the transition to risk-free rates. It provides a helpful assessment of the challenges faced by market participants as they deal with this fundamental change to market structure.”
Kenneth Bentsen, SIFA president and CEO stresses the need to prepare the market to transition away from reliance on LIBOR to ensure that both the cash and derivatives markets remain liquid and resilient when there is a move to new reference rates. “By laying the foundation now, through efforts such as the Transition Roadmap published earlier this year and the survey that is the basis for today’s report, along with participation with the Alternative Reference Rates Committee (ARRC), we are working to raise awareness, identify exposures and prepare for a smooth transition,” he says. “SIFMA and SIFMA AMG agree it is crucial to try to strive for consistency across geographical regions, product segments and market participants to both avoid fragmentation in global markets and permit the most effective risk management.”