We held back from sending this mail until last weekend was over. Last weekend was the main transition for CCPs[2], with all cleared GBP LIBOR positions converting to SONIA[3] + Credit Adjustment Spread (CAS). It all seems to have gone quite smoothly, which is fortunate as if things had gone pear-shaped the backup plan was conversion on 1 January, which would have put a dampener on New Year’s Eve celebrations (although omicron looks set to do that anyway!).

• CCP conversion: with 18 Dec behind us, we are now done on conversion of cleared swaps for all currencies (except USD); post conversion we are left with some non-market standard cleared SONIA trades adopting the fallback rate of 2d shift and fixed CAS, but we’ll see whether the market finds a solution to net these off with standard OIS4 over time.
• Fallbacks: 15,000 legal entities have adhered to the ISDA Fallback Protocol; these positions will have their last fixing reset against LIBOR in 2021 which will settle in 2022, then next payment period will fix on compounded RFR5 in arrears + CAS (see Bloomberg site); there is no ‘big bang’ here, the new rates will gradually become applicable as next resets come up; and no compensation fees and market practice is for no confirmations via MarkitWire or bilaterally when trades switch from LIBOR to RFR.
• Tough legacy: as we outlined in How Tough is Tough Legacy?, for anything that does not convert or fall back, there is a safety net in the form of the synthetic LIBOR rate (at least for GBP & JPY) that will be published from 1 January 2022 (though not necessarily for ever); based on Term RFR + CAS and published by ICE, any remaining legacy transactions on LIBOR will be eligible to reference it (but not new trades).
• Corporate lending tail: there will be a tail of lending contracts that do not get across the line by 31 December (as we predicted in The Loan Tail back in June); short term these will reference the synthetic LIBOR rate, though they may well not be genuine long-term tough legacy, rather just need a bit more time to agree transition; some of these also have linked swaps, which will match their loans on synthetic rate until such time as transition agreed, at which point they will likely switch on same basis as the loans (i.e. to 5d lag convention agreed bilaterally rather than the ISDA6 protocol 2d shift one).
• ICE Swap Rate (ISR): swaptions and CMS7 reference the ICE Swap Rate rather than LIBOR directly, and as such are not subject to the ISDA Fallback Protocol (if parties have adhered); instead post cessation either they are swap cleared (physically settled) in which case LCH has said they will continue to accept LIBOR swaps linked to exercise of legacy swaptions up until end 2024 at least; if cash settled then counterparties should agree bilaterally to reference the ISR Fallback published by ICE (which is based on Term SONIA + CAS); in absence of agreement then it will fall to the Calculation Agent to determine the rate (which will likely be the ISR Fallback as well!).
• EONIA8: sometimes not given the same air time as the core LIBOR transition activities, EONIA will also cease to be published on 3 January 2022; because it’s been pegged as €STR9 + 8.5bp since October 2019 the transition has been simpler; however that’s not to say there hasn’t been a lot of work going on in the background by legal and ops teams to repaper CSAs that reference EONIA as the interest rate for EUR cash collateral to €STR flat to match CCPs, and with that has come trade amends and offsetting fee payments to cover discounting valuation changes; anything still on EONIA come 2022 will just switch to €STR+ 8.5 with no economic impact (noting EONIA Protocol and EU legislation as well), so no major issues expected from cessation.
• USD LIBOR: the other big change to note is the prohibition on new transactions referencing USD LIBOR from 1 January 2022, with the exception of derivatives executed for risk management of existing positions, an equivalent mandate to the one that has been in place for GBP through most of this year; the recent statement from the FCA is strongly worded, building on the supervisory guidance issued by the US authorities in November 2020; worth noting this prohibition also applies to material amendments to existing loans such as extensions, and to transactions maturing ahead of final cessation in June 2023; the authorities have been trying to encourage SOFR10 liquidity and adoption for some time through various ‘SOFR-first’ initiatives; there are some signs of a market preference for Term SOFR versus SOFR compounded in arrears for some lending activity, but time is yet to tell what will end up as market standard.

So, it’s been a long journey to get here, but without tempting fate too much it does seem like it has been a course both the regulators and the market has navigated fairly successfully. It has been unlike many other market structure changes like Dodd Frank, EMIR11 or MiFID212 which had very prescriptive rules and a big bang go live. LIBOR transition has been much more market led, with the official working groups made up of both regulators and market participants nudging everyone along the way.

It has been a pleasure to be part of the efforts so far, and hopefully we have shed some light on some of the twists and turns along the way. We at NatWest look forward to continuing to provide commentary both on LIBOR and broader regulatory topics next year (look out for our “Year Ahead” in January).

In the meantime we wish everyone the very best over the holidays.

Notes

[1] LIBOR London Interbank Offered Rate

[2] CCPs Central Counterparties

[3] SONIA Sterling Overnight Interbank Average Rate

[4] OIS Overnight Index Swaps 5 RFR Risk-free Rates

[5] RFR Risk-free Rates

[6] ISDA International Swaps and Derivatives Association

[7] CMS Constant Maturity Swap

[8] EONIA Euro Overnight Index Average

[9] €STR Euro Short-Term Rate

[10] SOFR Secured Overnight Financing Rate

[11] EMIR European Market Infrastructure Regulation

[12] MiFID2 Markets in Financial Instruments Directive 2