# Libor Is Going Away Lets Talk Transition

Source audio: `audio\raw\libor-is-going-away-lets-talk-transition.mp3`
Compressed audio: `audio\compressed\libor-is-going-away-lets-talk-transition.mp3`
Model: `large-v3`
Language: `en`

[00:00:00.000] Hello, this is Jerry May with Ohio PERS.
[00:00:03.600] Welcome to another episode of Peer Connections
[00:00:06.320] by the GPFA, the Global Peer Financing Association.
[00:00:10.500] I'm joined today by Lisa Mantello from the Osler Law Firm.
[00:00:15.080] Welcome, Lisa.
[00:00:16.200] Hi, thank you very much for having me.
[00:00:18.440] Today, we're gonna talk about the transition
[00:00:20.940] from LIBOR to SOFR
[00:00:23.060] and other appropriate indices across the globe.
[00:00:27.080] But it was evident in 2012 that there was some manipulation going on with LIBOR.
[00:00:33.520] I don't know that there was an understanding at that point of how widespread it was or
[00:00:38.060] who was involved.
[00:00:39.080] But since that point, that's played out.
[00:00:41.660] And as of 2017 in the UK, the FCA announced that LIBOR was officially going away.
[00:00:49.400] So since that point, we have been sunsetting that index and moving in the US, at least,
[00:00:55.680] the ARC has recommended SOFR, the Secured Overnight Bank Funding Rate. And because of
[00:01:01.910] that transition, that has impacted a lot of beneficial owners, the buy side in particular,
[00:01:07.490] as well as the sell side. There are a lot of implications on both fronts. In March of this
[00:01:12.990] year, Lisa and I and her compatriot at Osler held a discussion for the peer group related to the
[00:01:21.230] transition from LIBOR to SOFR. Since that point, we've gotten a number of questions, a lot of
[00:01:27.390] positive feedback. So we thought we would include a podcast related to the subject because Lisa is
[00:01:33.550] a wealth of information and has a lot of good insights into this transition. And I can provide
[00:01:39.570] a little bit of market color from our perspective as well. So with that, I thought I would turn it
[00:01:45.390] over to Lisa to begin the discussion and give us a little insight into what has happened,
[00:01:51.410] where we are, and what we anticipate in the future. Great. Thanks so much, Jerry. So as Jerry
[00:01:57.150] mentioned, this is a complicated topic. It's a topic that really is industry-wide, and it affects
[00:02:03.210] a lot of different buy-side and sell-side institutions. It really all started with an
[00:02:08.830] announcement from the Financial Conduct Authority in the UK, which is that they will no longer
[00:02:14.110] encourage or compel panel banks that were providing LIBOR submissions from doing so.
[00:02:19.590] And part of that announcement was that market participants shouldn't rely on LIBOR continuing
[00:02:23.770] to be available, and that we should all start a transition to risk-free rates. That was a couple
[00:02:29.030] of years ago now, and there's been a bit of a progression, but it's been a slow progression
[00:02:33.150] to transition out of LIBOR. Recently, the UK's Financial Conduct Authority, I think it was on
[00:02:39.650] March 5th issued a key announcement with respect to the future cessation and loss of LIBOR
[00:02:45.270] representativeness. And what they announced was as of December 31st, 2021, UST LIBOR for one week
[00:02:53.090] and two months, tenors will cease to exist. So that's coming up. And then for all other remaining
[00:02:57.970] UST LIBOR settings, which is overnight, one month, three months, six months, and 12 months,
[00:03:04.070] that those will all cease to exist June 30th, 2023. So those are dates that are coming up.
[00:03:11.110] And I think this has a big impact on legacy contracts. And there's really three different
[00:03:16.670] areas that we like to bucket the types of legacy contracts, the types of LIBOR references in.
[00:03:21.890] One is the derivatives market. And to a large extent, that really has come with an industry
[00:03:28.090] solution as ISDA has put out a benchmark fallback supplement and protocol and what
[00:03:33.910] they've done is they have a transition rate which is SOFR plus an adjustment for the spread and
[00:03:40.210] they've solved that problem for the derivatives industry and from what I understand there's been
[00:03:44.490] a lot of take up on people signing up to that protocol and really implementing and there's a
[00:03:50.150] lot of traction with that change. Then there is the floating rate note market and that to me is
[00:03:57.070] also another complicated area reason being that existing contracts which have LIBOR in them
[00:04:02.670] will need to be amended to the fallback rate, which would be SOFR. But a lot of those documents
[00:04:09.270] require no holder consent to do so. So that's something that's taking a bit more time. And then
[00:04:14.190] sort of in the middle, I would say is the loan market. And in the loan market, that's also quite
[00:04:19.050] a large task of amending all of the loan documents. And I think there's been consensus in the loan
[00:04:25.010] market that there will be SOFR, but SOFR can be calculated in different ways. It can be either a
[00:04:30.870] simple average or compounded average. It can be calculated in advance or in arrears. And I don't
[00:04:35.810] think the loan mark has really established what the go-to SOFR market is going to look like.
[00:04:42.150] Jerry, what have you found? Have you found that you've heard a lot on one of the three areas,
[00:04:46.990] or has this been a problem for Ohio PERS in all the product areas?
[00:04:51.710] Yeah, we've actually engaged a committee within OPRS in the investment area to look at some of
[00:04:57.370] these issues that you just brought up. We've compounded that with our legal area and their
[00:05:01.890] discussions with market participants. Derivatives, I think we're a little more comfortable with that
[00:05:07.830] we kind of know what's going to happen there. The floating rate note issuance is a little
[00:05:12.970] different issue for us. The cash portfolios that I'm in charge of are the primary portfolios in
[00:05:19.870] which we have pulled LIBOR instruments. And we have not purchased those at OPERS for a number
[00:05:26.470] of years now trying to push industry participants to move to SOFR or to an alternative rate. I mean,
[00:05:32.610] it could be Fed funds or T-bills and any index would do. So from our perspective, yes, we're
[00:05:38.370] ready to go, I think, but I still see a lot of issuance in LIBOR in the short-term market,
[00:05:44.650] specifically ABS, but also some corporate issuance as well. So one thing that I would
[00:05:49.630] like to know, at least from your perspective as the expert in this area, what do you think
[00:05:54.650] the triggers are that issuers would look for in the marketplace to stop issuing versus that index?
[00:06:01.350] Well, ARC has recommended that that issuer stop issuing on LIBOR, but I know this in my practice
[00:06:07.670] that that's not really happening. So I think it's been difficult to get traction to take for people
[00:06:13.030] to say, now we must do this. We suggest that clients do not issue LIBOR and to continue
[00:06:19.630] issuing LIBOR given that it will cease to exist. And most of it will cease to exist in June of
[00:06:24.570] 2023, which is not that long given a lot of the maturities on bonds or on loans would exceed that
[00:06:31.930] date. So our recommendation is really to look to the SOFR market. But for the most part, I do still
[00:06:37.850] see issuers on bonds and in loan agreements referring to LIBOR and still using the LIBOR rate.
[00:06:44.510] What I can say has happened in the loan market, though, is that there has been amendment language
[00:06:49.850] put into the loan documents. So it may not say we will be issuing SOFR immediately as a closing
[00:06:56.150] of the loan, but there is fallback language that says once LIBOR ceases to exist, which will likely
[00:07:01.930] be June 2023, then we will fall back to SOFR. What's at issue now in all of that amendment
[00:07:08.510] language, and we've spoken to a number of bank clients about this, is whether the actual adjustment
[00:07:14.010] should be put into the amendment language itself. So ARC has suggested this and what it says is the
[00:07:20.730] fallback rate will be SOFR plus a particular spread and that spread is baked in already and
[00:07:25.910] it's decided as of now. And for the most part, I think it's been a slow take up on that. I think
[00:07:31.370] it's been quite slow for parties to agree that not only will we fall back to SOFR, but we'll also
[00:07:36.830] include what the adjustment will be right now at this moment. And that raises an interesting
[00:07:41.670] question because we've done a little bit of work here. Michael Latko on my team looked at
[00:07:47.230] performance of SOFR versus LIBOR through the 2020 episode with the coronavirus and found that
[00:07:55.410] during March and April in particular, when the volatility in the market was highest,
[00:08:01.050] the spread between SOFR and LIBOR actually reached 144 basis points with a standard deviation of 46
[00:08:07.470] six basis points. Now that compares with the rest of the year, May through December, where the spread
[00:08:13.530] between the two was only 13 basis points with a standard deviation of eight basis points. So it
[00:08:21.050] depends really on what the deciding numbers are going to be as to who might get the benefit of
[00:08:27.710] that, because in a volatile environment, there definitely should be a wider spread between SOFR
[00:08:33.130] and LIBOR. But in a typical environment or a low volatility environment, that spread is very
[00:08:38.490] minimal. So that's an interesting dynamic that's going to play out here in the market, I think.
[00:08:43.830] Absolutely. And do you think, Jerry, that may be one of the reasons why issuers or loan parties
[00:08:48.730] are reluctant to use SOFR at this moment, because we're just not sure the way we'll behave and
[00:08:54.070] worried about fluctuations in the market? I think you're spot on. I agree 100% with that. Yes,
[00:09:00.110] There's definitely some consideration of the spread component that is in LIBOR, but not in SOFR, because SOFR is obviously based upon Treasury repo, and it's a secured rate.
[00:09:11.770] So there's no credit component associated right now with SOFR.
[00:09:16.050] And then the second is that you have the dynamic related to the forward-looking rates that LIBOR typically used.
[00:09:23.830] You could find a one-month or three-month or six-month rate based on LIBOR.
[00:09:27.710] So very forward-looking, whereas SOFR is an overnight index rate.
[00:09:33.110] And that is another component that challenges a lot of people to issue versus SOFR and on
[00:09:38.890] the buy side to buy it because there's no term structure right now associated with it.
[00:09:44.650] And from what I heard within the last two weeks, it appears that ARK is saying that
[00:09:49.970] they don't anticipate that they're going to hit their targeted deadline, which I think
[00:09:54.270] was the midpoint of this year to have some term structure associated with SOFR. And they may not
[00:10:00.730] have one throughout the remainder of the year. That too presents a challenge. Have you heard the
[00:10:05.250] same? I have. I've heard the exact same thing. And what I wanted to ask just on that comment is
[00:10:10.610] we've heard a lot of criticism about SOFR not having a credit component. And I think there's
[00:10:16.130] an undercurrent of players who would like to use something other than SOFR, particularly in the
[00:10:22.070] loan market. And there's been a suggestion of Ameribor. So I'm wondering what you think about
[00:10:26.930] that. Do you think that will gain traction? I haven't seen that used very frequently in Canada.
[00:10:32.150] I know it seems like it's more of a regional bank thing in the U.S. What are your thoughts? Do you
[00:10:36.470] think that'll gain some traction as an alternative? You know, I've heard that too. And I'm not one to
[00:10:41.930] make predictions at this point. So I'm not 100% sure. But I would say that alternative rates
[00:10:48.350] in particular are definitely something that are being explored right now. I know that Bloomberg
[00:10:53.570] recently came out and published the BSBY index, and that received IOSCO confirmation within the
[00:11:00.910] last week. So people are definitely looking to see what alternatives are out there that might
[00:11:07.140] include term structure and credit component so that it is closer to LIBOR. So yeah, I think
[00:11:13.060] people are looking right now to see what else they can use. That's definitely been consistent
[00:11:17.440] with what our clients are telling us. The other criticism I hear of SOFR is the potential mismatch
[00:11:23.780] in the derivatives market. Because I think, as I mentioned, the ISDA fallback rate is it's SOFR
[00:11:29.280] set in arrears. So I think there is some concern over if you use SOFR for the lending market,
[00:11:34.540] that is set in the future as opposed to in arrears. Will there be a mismatch in the rates,
[00:11:39.940] which could cause some concerns when you're hedging a credit agreement, for example?
[00:11:45.420] That's a great point too. Yeah.
[00:11:46.920] So I think that's going to have to be a problem that the market considers.
[00:11:50.980] Agreed. Yeah. I think there's a lot of uncertainty right now that people are trying to work around.
[00:11:56.420] I think what's interesting is just based upon what I've heard over the last several weeks is that you've had Randall Quarles come out and say that the U.S. is ready to start penalizing banks that continue to use LIBOR.
[00:12:10.120] That's going to light a fire under some people, I think.
[00:12:13.080] I think it's great.
[00:12:13.940] And then it also seems that regulators are trying to get people incentivized to move toward creative solutions if SOFR is not the right index for their particular platform or for the loans that they're looking at to get creative with something else that might be able to use.
[00:12:34.300] Yeah, absolutely. I think that's definitely part of the problem.
[00:12:37.060] I think another part of the problem, both on the buy side and sell side, would be just getting clients familiar with what the amendments would look like for legacy transactions and for going forward, getting people comfortable with the SOFR rate.
[00:12:52.280] I do think there is an educational component here.
[00:12:54.800] And for example, in the loan market, I think banks have found that approaching borrowers, saying to them, okay, now we will be amending your interest rate, which is so fundamental to the contract.
[00:13:05.840] I think that that often leads to quite a bit of confusion on the borrower side.
[00:13:10.920] And I think that's some of the reluctance around going to SOFR-based loans or building
[00:13:15.980] in the hardwired language, which says we will use SOFR plus this built-in spread.
[00:13:21.620] I think it makes people nervous.
[00:13:23.580] Yeah, totally agree.
[00:13:24.880] And it's not just consumers or people that are not as familiar with the financial markets.
[00:13:30.260] I think there are traders or portfolio managers that are still a little concerned about it
[00:13:35.380] as well, and probably need a little more education on their front as well.
[00:13:40.040] Yeah, I think that's definitely true.
[00:13:41.820] I think education is key.
[00:13:43.500] So I'm glad we're doing this for all of the listeners and at least raise some of the issues.
[00:13:48.720] We may not have solutions to the problems, but at least we can identify what the issues
[00:13:52.420] are.
[00:13:53.760] Yeah, absolutely.
[00:13:54.880] Hopefully this is helping some people on the buy side with some information that they need,
[00:13:59.760] taking it to management, making them aware.
[00:14:02.200] because last I heard there was $200 trillion in contracts that are associated with LIBOR
[00:14:08.460] that are needing to be transitioned. So that's not an insignificant amount.
[00:14:13.000] No, it's not. I think that's exactly right. So what we advise people on the buy side to do,
[00:14:18.480] the first step is the scoping exercise to see what your legacy contracts look like and to look at
[00:14:25.140] how many of them do reference LIBOR. And if they do reference LIBOR, do they have any amendment
[00:14:30.700] language in them. So I would say that it's only probably been in the last year or so that people
[00:14:35.700] have been putting amendment language in documents. And by amendment language, I mean language that
[00:14:40.300] says once LIBOR ceases to exist, that this is what we will do. And it's usually either one of
[00:14:45.740] two things, either an amendment approach, which is what ARC calls it, which is basically the idea
[00:14:51.060] that we will amend it at the time that it ceases, or this hardwired approach that I previously
[00:14:56.220] mentioned. So I think the first step is a scoping exercise and looking at what's affected and then
[00:15:02.260] looking at if there is amendment fallback language. And then the third thing I would say
[00:15:06.360] is looking at just the general amendment language in the document to look at how do we amend this
[00:15:12.640] document. And this is why I think in the FRN market, it's so difficult because amending note
[00:15:19.480] documents, amending a trust indenture is really quite difficult and requires a significant amount
[00:15:25.020] of note holder consent, particularly if we're talking about something as fundamental as the
[00:15:29.840] interest rate. So this is what I would say. Step one is really scoping, then looking at the
[00:15:34.580] amendment language, seeing what it allows you to do or not. And buy side entities may be in control.
[00:15:41.220] It depends on what role you're playing, right? If you're a note holder, I think it's a situation
[00:15:46.020] where it's obviously good to know what your documents say, but you may not be in the driver's
[00:15:50.760] If you are a lender, and I know some beneficial owners are lenders to institutions, that may be something that you'll need to get on top of relatively quickly.
[00:16:00.500] Yeah, agreed. And as I mentioned internally, we have people from investments group participating in this transition committee, also on our legal side, obviously.
[00:16:09.680] From your perspective, we're just one organization, though. How would we best engage with an industry that's going through this transition?
[00:16:18.020] I think that's a tough one.
[00:16:19.020] I think on the derivative side, I think that that's sort of done and there's been an approach.
[00:16:23.000] And I think ISDA is always there as the industry leader in derivatives.
[00:16:26.600] So I think that's organized for you.
[00:16:28.480] I think on the loan side, it's much more difficult.
[00:16:31.500] There is the LSTA and they've been putting out more documents.
[00:16:34.720] So more advice on what amendment language looks like.
[00:16:38.360] And they're always open for comment and they have a number of sessions on advising people.
[00:16:43.660] But my sense of it is it's not really the same industry standard that you have in the
[00:16:48.240] derivatives market.
[00:16:49.600] So I think we've talked about SOFR as an alternative.
[00:16:54.060] We've also talked about some of its inherent limitations regarding the term structure and
[00:16:58.460] the credit component.
[00:17:00.000] I thought I would bring up, though, that SOFR is, there are a lot of positives associated
[00:17:04.540] with it.
[00:17:05.020] And I've got four that I can think about.
[00:17:07.240] Number one would be that it's not a manipulated or able to be manipulated easily rate because
[00:17:12.440] it's based on overnight treasury borrowings in the repo market. Second would be the depth of
[00:17:17.400] the market is sizable. I think it's over $1 trillion on a daily basis. So that provides
[00:17:22.080] a foundation. Number three would be that it's published by the Federal Reserve, obviously a
[00:17:26.940] standard industry participant regulator overseer that instills a lot of confidence. And then number
[00:17:32.860] four is that it's published every day. So I think all of those speak highly of SOFR, but there are
[00:17:38.940] definitely some positives there, but there are some inherent negatives as well that need to be
[00:17:42.780] overcome. I think that's absolutely true. I think all of those four are very important. And I think
[00:17:48.740] a lot of them lead to transparency, which is super important, especially given why we're doing this
[00:17:54.600] and why we're moving away from LIBOR. So I think that is something that can give people some
[00:17:59.180] comfort that it really is quite a transparent market that cannot be manipulated. Yeah,
[00:18:04.020] Absolutely. All right. Well, Lisa, this has been a great conversation. Thank you very much for your
[00:18:09.360] insights. Really appreciate those. You've given us a lot to think about. My pleasure, Jerry. Thank
[00:18:14.320] you for having me. Thank you to the listeners who've tuned into the podcast here at Peer
[00:18:19.680] Connections by the GPFA. GPFA continues to grow. We're adding new members consistently. We strive
[00:18:27.220] to provide some sound educational material for folks to give them something to think about,
[00:18:32.200] to take back to their organizations. The LIBOR transition discussion was one of those topics
[00:18:37.300] that we tackled back in early March, and we thought it was useful to get out to a larger
[00:18:42.340] audience, to others that may find that useful as well. Also wanted to make everyone aware that we
[00:18:47.960] do have our Global Peer Financing Association upcoming quarterly meeting later this month in
[00:18:54.080] April. If you can join that, please reach out to any of the GPFA members or on the website.
[00:18:59.320] We can provide details or get you in touch with people that can help you with that.
[00:19:03.960] Outside of that, if you are currently thinking about joining the GPFA, we'd love to hear
[00:19:08.820] from you.
[00:19:09.400] If you've got topics that you would like to talk about, please reach out.
[00:19:12.800] We are looking to help people to find experts in areas that can provide some assistance
[00:19:17.600] with organizations that are participants in this group.
[00:19:20.680] And we think we're leading that charge right now, and we'd like you to come along with
[00:19:25.520] us.
[00:19:25.760] So that being said, we appreciate your listening and please join us for the next installment of Peer Connections on the GPFA site. Thanks.