The clock is ticking

LIBOR Insights

This article is by Kevin Sinclair for Bloomberg News

With the arrival of 2020, less than two years are left on the Bank of England’s countdown clock for retiring the scandal-plagued London interbank offered rate — at the end of 2021, the U.K.’s Financial Conduct Authority will no longer require banks to participate in the LIBOR panel.

The idea was that contributors would step away, and the market would be forced to find another benchmark. But so far there’s not much unity: The U.S. created a would-be replacement, the secured overnight funding rate (SOFR), and the Bank of England is touting the sterling overnight index average (Sonia). The European Union has been a bit more meandering, but a new rate that launched on October 1, 2019 — the euro short-term rate (ESTR) — apparently will be the focus there.

Of course, when it comes to derivatives, the devil always lurks in the details. In a traditional LIBOR coupon in a swap, fixing occurs at the beginning of the period, so the size of the cash flow for the payment at the end of the period is known well in advance. But for swaps based on these new overnight rates, the coupon is calculated by daily compounding of the underlying rate. As a result, the final rate for the payment is not known until the day before it’s due.

The bond market has experimented with different approaches to this problem. In May, Goldman Sachs introduced a SOFR bond that shifts back by two days the period over which the daily rates are compounded. And Morgan Stanley priced a SOFR bond in June that matched this convention.

The issue

Bloomberg solutions offer a number of options for sorting through financial instruments related to the transition away from LIBOR. For example, Bloomberg’s Index Compounding Calculator (see next page) can help in figuring out the final rate for payment of swaps based on the new overnight rates. And the Swap Manager function can price swaps based on the new benchmarks. Note that as these markets become more liquid, the curves used to price trades will become more detailed.

There’s also the Contract Table Menu function for information on new futures contracts launched by exchanges. And clients are using Bloomberg’s MARS API to programmatically assess the change in present value that a re-papered credit support annex might cause. In addition, you can set up alerts to be notified when a bond in your portfolio is marked to begin the change in coupon process.

Tracking

Go to EONC for the Index Compounding Calculator

LIBOR transition series - ISDA fallback rates

On the Bloomberg Terminal

Clients can perform what-if portfolio analysis to determine what happens to their derivatives in the event of cessation. The MARS API can perform this analysis in a number of different ways, allowing users to:

• Create custom scenarios to replace LIBOR curves with OIS data (rates) to value and analyze risk impacts of a LIBOR cessation event at a given point in the future
• Incorporate offsetting basis swaps programmatically to cancel out future LIBOR exposure
• Construct a hybrid curve comprised of LIBOR and RFRs for use in risk and valuation analysis
• ​​​Watch this short video below featuring our Pricing and Risk analytics for LIBOR transition solutions: