Timing last orders on US Libor

Exactly when Libor’s regulator will sign the official death warrant for the most popular US dollar settings is now a cause of huge uncertainty. It’s also a matter of huge significance. 

An 18-month stay of execution – which will see five dollar tenors disappear after June 2023  – means the UK’s Financial Conduct Authority (FCA) could delay the announcement on those fixings until mid-2022. On the other hand, it could call time on all five Libor currencies together – likely after January 25, 2021, when fallbacks devised by the International Swaps and Derivatives Association (Isda) become effective.

Among market participants, there is little consensus. An audience poll at Risk.net’s Libor Telethon on December 8 showed a 55/45 split between those who expect a ‘big bang’ announcement covering all currencies and those who think it will be staggered.

Comments from the FCA suggest the first camp might be right. Speaking at the same event, Edwin Schooling Latter, director of markets and wholesale policy at the UK watchdog, noted the significance of all currencies – including the delayed dollar settings – being included in the ICE Benchmark Administration’s Libor cessation consultation, published on December 4.  

“The fact that it is a single consultation should make it possible to determine and make announcements on the future path for all five Libor currencies simultaneously, even if the proposed cessation date is different to end-December 2021,” he said. 

A single-swoop announcement would fix the credit adjustment for Isda fallbacks – calculated as a five-year historic median – across all currencies and tenors together. This could be some two-and-a-half years before US dollar Libor swaps finally get booted onto US Libor’s successor – the secured overnight financing rate (SOFR).  

Speaking at the same event, Subadra Rajappa, head of rates strategy at Societe Generale, supported a one-step call. “I think having one day is important because Isda fallbacks will be calculated on that one day. Having one day for the spread calculation avoids confusion, even though there are some tenors that are being discontinued earlier.” 

She adds this approach would also make more sense in cross-currency basis markets, where instruments include dollar and non-dollar legs.

Yet an early announcement doesn’t sit easily with some participants. “To fix a five-year lookback spread that won’t be applied for another couple of years doesn’t really make a lot of sense to me,” said Mark Cabana, head of US rates strategy at Bank of America. 

He warned that an early call, where the fallbacks fix in early 2021, means this spread adjustment includes data from 2016, when US money-market mutual fund reform caused a blowout in the dollar Libor-overnight index swap spread. 

“Should you really be enshrining that for the next 30 years? I don’t think so,” Cabana said. “I understand the benefits of having one clean announcement and making it nice and neat, but why would you discount the next several years in which Libor is probably going to set quite low and closer to SOFR?”

In simple terms, an early announcement is more likely to deliver a bigger fallback adjustment than a later one. The debate is far from settled, but swap holders paying the floating leg on dollar instruments probably shouldn’t rest too much hope on a late – and economically beneficial – call. 

 

Libor Risk – Quarterly report Q4 2020
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