Financial industry in last-minute sprint to move away from Libor

Banks, fund managers and other firms rapidly step up their use of Libor replacement rates in derivative transactions in the last quarter of 2021, as the benchmark of tarnished loans nears its close day .

Majority of volumes of new privately traded swap agreements in British pound, Japanese yen, Swiss franc and Singapore dollar, now largely use the new so-called “risk-free” rates that authorities prefer over Libor, according to data from Osttra , a UK data provider.

These swaps had proven to be a particularly thorny issue in the course of the four-year regulatory push to cut the Libor lending rate in late December, accounting for the bulk of the $ 265 billion in Libor-related deals outstanding.

This means that the increased efforts to switch to new alternatives marks a key step in the retirement of what was once one of the most important benchmarks in the financial markets.

After the scandals, during which investment bank traders attempted to rig the rate, and its waning relevance to market activity, UK regulators decided to remove Libor from the end of 2021. Twenty- four of the 35 daily Libor settings will cease in January; another six will continue temporarily in synthetic form, as a fallback to help the market tip over, but could be halted over the next 18 months.

Trading volume referencing Sonia, the replacement for the Libor sterling, has reached 80% in each of the past three months while Tona, the replacement for the Japanese yen, has reached 71%, Osttra said. The saron, the equivalent of the Swiss franc, reached 78%.

“Clients who proactively ditched Libor had the benefit of designing the components of their new portfolio instead of having the terms dictated by fallback solutions,” said Bhas Nalabothula, Head of European Institutional Rates at Tradeweb.

The lagging behind remains the US dollar Libor, the highest and most important Libor rate, and UK regulators have allowed five listings to continue until June 2023 to explain the slow progress.

But banks will no longer be able to take out new loans using Libor from 2022, and Libor’s share of new swap business has fallen from 90% in August to just 68%, Osttra said.

Line chart of swap volume referencing the benchmark (%) showing sterling Libor falling out of favor

Kirston Winters, head of legal, compliance and government affairs at Osttra, said progress has been made in some currencies. “There is clearly still some way to go for the new risk-free rates to completely replace ‘-ibors’ in global swap trading,” he said.

The majority of open trades are held in clearing houses, which stand between the parties to a trade and prevent a default from infecting the market. The companies that run the biggest ones, such as LCH, ICE Clear Europe, CME Group and Eurex, are gradually switching their contracts open. Earlier this month, LCH, the world’s largest clearinghouse, converted around 100,000 Swiss franc, euro and Japanese yen derivatives, with a notional value of $ 6 billion, to the new rate. Over the weekend, he will switch swaps of pounds sterling, worth around $ 19 billion, at the alternative rate.

Line chart of swap volume referencing the benchmark (%) showing the US slowly starting to move to new rates

In a speech last week, Edwin Schooling Latter, who is leading efforts to move to the Financial Conduct Authority, said the UK regulator has in the past been concerned about the pace of developments in US dollar markets, but that this change had been dramatic as investors. started using Sofr, the US dollar Libor surrogate. “All of these numbers are now better than I would have dared to predict a year ago,” he said.

Despite this, the regulator expected that some Libor-based swaps would not be prepared for the change, especially on transactions where a party had not completed documents.

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