Financial Industry Alert | July.22.2019
SIFMA hosted a briefing on July 15 at which presenters from the NY Fed, FCA, ARRC, Wells Fargo, Freddie Mac, Fannie Mae and SIFMA discussed the progress that has been made thus far in preparing for the transition from LIBOR to alternative reference rates, including SOFR and SONIA, and the lift that is still required. Below is a bullet form summary of the key takeaways.
Some signs of progress…
. . . and some ominous notes...
Current State of LIBOR
“LIBOR is essentially broken.” Very thin market; rates fell in the credit crisis while credit premiums rose; would likely be a thinner market if a crisis arose again.
“Any new LIBOR contract creates a deeper hole to climb out of. The best way out of a hole is to stop digging.” Notwithstanding the above, contracts referencing U.S. dollar LIBOR without robust fallback rates continue to be issued.
If LIBOR were to continue on an “unrepresentative” basis, this would create more uncertainty; “Fixing” LIBOR is not one of the options. Parties should elect alternatives where possible. Legal disputes could ensue in cases where an acting party exercises discretion to set the rate.
Spread adjustment consultation forthcoming in second half of 2019.
“There are 901 days left until the end of 2021 and the clock is ticking.”
“The existence of LIBOR beyond 2021 is not guaranteed. You should not think that you will be able to force the continuation of LIBOR beyond the end of 2021.”
Best case assumption: no LIBOR publication after 2021. If there is publication, it’s not likely to be “representative.” Ability to hedge will be impaired. “Transitioning comfortably before the end of 901 days is the best choice.”
After 2021, LIBOR panel bank departures are expected. It may no longer be viable to publish rates.
If the rate continues with fewer observations based on fewer transactions and fewer banks, will that be considered a market rate? [Will the benchmark determination be representative of market value as required by the EU benchmarks regulation?] Will there be a market?
A reduced number of panel banks may not meet the EU benchmark’s regulation contemplation of [“data from a reliable and representative panel or sample of contributors so as to ensure that the resulting benchmark is reliable and representative of the market or economic reality that the benchmark is intended to measure”].
“Please do not have any confidence that the “representative” test will be passed.”
What are the consequences if LIBOR is deemed not “representative”? EU regulated firms would not be allowed to use LIBOR.
Review of the benchmark regulation is forthcoming. “Do not rely on the review to put off a transition.”
SONIA (Sterling Overnight Interbank Average Rate)
Cash market; SONIA is now the market standard in the UK.
Securitization markets: two-thirds of new public deals use SONIA.
Forward looking term rates yet to be fully developed, but overnight SONIA, compounded in arrears, is used in the bond market – also in the securitization market in the UK.
“The industry must not wait for a SOFR term rate to transition away from LIBOR.”
“Delaying transition while waiting for term rates is not the right thing to do.”
Optimistic – but no guarantees – that term rates will develop. “Please do not wait.”
Legacy and “Tough Legacy”/Legislation Solution
Legacy contracts: “we cannot offer certainty unless there is a transition now.”
See if and whether a consensus exists to address the tough legacy issues. There is no magic bullet here. Associated British Ports prove that there is a consensual way through legacy conversions; bondholder approval was received. Financial Times
“Tough legacy”: unanimous bondholder consent required; unclear language; litigation risk, especially in the U.S.
“Possibility of a legislative solution should not be taken off the table, but please do not rely on a legislative solution. Legislation in UK and NY State and possibly other jurisdictions may be required.”
Residential Mortgages (U.S.)
$1.2 trillion in legacy ARMs.
No clarity re “no longer available” in fallback language in current residential adjustable rate mortgage notes; no process for replacement index; no spread adjustment.
The ARRC released a consultation on USD LIBOR fallback contract language for new residential ARMs, and also released a white paper detailing how average SOFR can be used in newly issued ARMs in a structure that is comparable to today’s existing ARM loans. September 10 is the deadline for comments.
Borrower needs to have certainty regarding the payment to be made ahead of the payment period. Calculation "in advance" proposed.
Twelve to eighteen months of systems development will be required for implementation of the new product.
Objectives: Ensure an orderly, fair and transparent outcome; minimize value transfer; minimize possibility of disputes by limiting the need for use of discretion.
Ensure the highest standards of care required for consumer products.
Other Consumer Products
Consultations for reverse mortgages/HELOCs/student loans/personal loans/consumer loans/car loans to follow.
“In this primer from SIFMA Insights, we provide an overview of the LIBOR transition, with a focus on the proposed U.S. alternative reference rate, Secured Overnight Financing Rate (SOFR).” SOFR Primer
John Williams, President and CEO of the New York Fed
Andrew Bailey, CEO of the UK’s Financial Conduct Authority
Thomas Wipf, Chair of the ARRC
Brian Grabenstein, Head of LIBOR Transition Office, Wells Fargo
Nadine Bates, SVP/Treasurer, Fannie Mae
Timothy Kitt, SVP, Head of Pricing and Execution, Freddie Mac
Ken Bentsen, President and CEO of SIFMA