Wall Street Banks Manipulated LIBOR In Rigging Us Treasury Auctions (#GotBitcoin?)
The antitrust probe was focused on whether Goldman Sachs traders colluded with others to fix prices in the $13 trillion Treasurys market. Wall Street Banks Manipulated LIBOR In Rigging Us Treasury Auctions (#GotBitcoin?)
Why Ditching Libor Is Vexing The Financial World
Declaring an end to Libor is one thing, making it happen another altogether. The deadline to drop the discredited London interbank offered rate is approaching at the end of 2021, leaving the financial world scrambling to adjust contracts on hundreds of trillions of dollars’ worth of products, from mortgages and credit cards to derivatives.
The risk of a chaotic transition has been likened to Y2K and the fear of computer systems misfiring at the end of the last millennium, only with the added challenge of a global pandemic thrown in. Whether the outcome will be as benign as Y2K turned out for the financial industry is about to unfold.
1. What’s The Worry?
As much as half of the outstanding Libor-priced contracts expire after the deadline. That means the clock is ticking to switch those agreements — often termed “legacy contracts” — to non-Libor rates. The process has been delayed somewhat by the pandemic, while the sheer breadth and scale of Libor’s use means that multiple industries and regulators are having to adjust.
In practice, some are doing so with more urgency than others.
2. What Is Libor And Why Is It Disappearing?
For about 50 years, Libor has helped determine the cost of borrowing around the world. It is a daily average of what banks say they would have to pay to borrow from one another and forms the basis for floating-rate or variable loans and bonds, as well as derivatives.
The London-based British Bankers’ Association formalized the gauge in 1986 when it needed a way to price interest-rate swaps and syndicated loans. But as markets evolved, the trading that helped inform banks’ estimates dried up. And ever since evidence emerged in 2008 that European and U.S. lenders had manipulated rates to benefit their own portfolios, the benchmark has been seen as tainted. By the end of 2016, a dozen banks had paid penalties approaching $10 billion.
3. Who Cares?
Lots of people do. They include pension and fund managers, insurance companies, lenders big and small and Wall Street banks that package loans into securities. Equipment leases, commercial paper, sovereign bonds, student and auto loans, bank deposits and mortgages are among the $370 trillion of financial products that the International Swaps and Derivatives Association says are tied to Libor and related interbank rates. The biggest use is for derivatives like interest-rate swaps, which companies, banks and investors use to hedge risk or to speculate.
4. What’s Taking Libor’s Place?
Central banks have been working to develop replacement benchmarks based on what are called risk-free rates. The goal is to find rates that are a truer reflection of the cost of capital, and are based on actual transactions.
The upshot is an array of acronyms with varying degrees of catchiness, including the U.S.’s Secured Overnight Financing Rate (SOFR), the U.K.’s Sterling Overnight Index Average (Sonia) and the Euro Short-Term Rate (ESTR).
5. How Do The Replacements Stack Up?
In one important aspect they fall short. Libor offers forward-looking rates — that is, rates that incorporate market expectations for the cost of borrowing over a particular time scale, from overnight to a year. By contrast, the new benchmarks mostly reflect overnight lending rates. SOFR, for instance, is based on the U.S. repo market, where cash is briefly exchanged for high-quality securities such as U.S. Treasuries.
In A Post-Libor World, Here Are The Benchmarks That Will Matter
6. Why The Trepidation Over Loans?
Rewriting legacy contracts so they track an overnight benchmark instead of, say, a three-month rate, would be hugely complicated and probably requires renegotiation. Lawyers say many such contracts may end up in court since getting unanimous agreement on a replacement or “fallback” rate would be difficult.
“The big elephant in the room is legacy transactions which have no fallback provisions,” said Y. Daphne Coelho-Adam, counsel at Seward & Kissel LLP in New York. “There is a risk of litigation.” Moody’s Investors Service has warned of increased credit risks due to slow progress on switching from Libor.
Libor’s End Is $12 Trillion Headache For Loan Bankers: QuickTake
7. What About The Derivatives Market?
There’s less concern there. A protocol taking effect in late January will enable firms to incorporate so-called fallback language into contracts, so they can transition smoothly into replacement benchmarks. That will help firms avoid complicated renegotiations and a cliff-edge Libor scenario.
An estimated $200 trillion of financial contracts reference dollar Libor alone, with 95% of this exposure in derivatives, according to the Federal Reserve Bank of New York. Widespread adoption of the protocol is necessary to mitigate broader risks, according to the Financial Stability Board, an international body that monitors the global financial system.
A milestone was reached in October when interest-rate swaps on more than $80 trillion in notional debt switched to the new U.S. benchmark SOFR as the discounting rate.
America’s Libor Successor Is Racing To Gain Traction: QuickTake
8. What Are Governments Doing?
The U.K. is handing regulators extra powers to help with legacy contracts that can’t be easily renegotiated. In the U.S., planned New York state legislation would incorporate recommended fallback language for particular products in an effort to enable automatic transition to other rates.
However, lawmakers have been so preoccupied with Covid-19 that the draft law has been held up, fueling anxiety on Wall Street.
Here’s Why Libor’s End Is A Headache For Switzerland: QuickTake
9. How Else Has Covid-19 Changed The Landscape?
It disrupted the campaign to ditch Libor and even intensified its use. Both the U.S. and U.K. governments allowed Libor to be referenced as part of emergency loan programs to help keep businesses afloat. The Bank of England delayed plans to encourage banks to ditch the rate and the U.K. pushed back a deadline for lenders to cease issuing Libor-linked contracts.
10. How Will This Affect Regular Consumers?
There’ll be scrutiny over whether they will be forced to pay higher rates. Banks and asset managers face a greatly increased risk of fines, litigation and reputational damage if they poorly manage the transition for existing contracts and products, with regulators likely to watching closely whether they are treating customers fairly.
11. Will Libor Be History From 2022?
Regulators insist the transition won’t be delayed, but be prepared for a possible “synthetic” Libor. The U.K. regulator has hinted at the continued publication of the benchmark using a “more robust” methodology not based on bank submissions. This would only be applicable for legacy contracts that can’t switch to another rate. Details remain sketchy.
The probe, which exposed weaknesses in the way the US Treasury prices the interest on the country’s debt obligations, has been an embarrassing one for Washington since it was first exposed in June 2015.
Investigators are hitting dry wells in their evidence hunt through thousands of pages of Bloomberg chats, plus dozens of interviews, to bring a clear case, one law enforcement official familiar with the probe told The Post.
“There just wasn’t enough there,” the person said.
The probe, which exposed potential weaknesses in the way the US Treasury prices the interest on the country’s debt obligations, has been an embarrassing one for Washington since it wasfirst exposed by The Post in June 2015.
Jacob Lew, then head of the Treasury under President Barack Obama, wanted a quick resolution to the probe soon after it was revealed, The Post reported in 2017
Since then, Lew was replaced by Goldman alumnus Steve Mnuchin, who is now Treasury secretary under President Trump. Another ex-Goldman partner who joined the White House, Gary Cohn, had overseen the division that submitted the bids to Treasury at the time.
No one has accused Lew, Mnuchin or Cohn of any wrongdoing in the matter.
While charges are unlikely to be filed, it’s not clear that banks won’t suffer some negative consequences.
A class-action lawsuit filed in 2015 showed that, after The Post first broke the story, banks changed their behavior in how they bid for Treasury bonds.
The suit, which was brought on behalf of pension funds and investors, also relied on a confidential informant who helped describe how the banks allegedly rigged the Treasury markets.
As recently as 2017, Department of Justice investigators were focused on a period from 2007 to 2011 when Goldman was particularly successful in bidding for Treasury bonds, sources told The Post in 2017.
Since then, however, a string of departures at the department also slowed the investigation, a third source told The Post.
The talks between Goldman and the feds have been “inactive,” another person familiar with the talks told The Post.
The investigation was one of many that looked into banks for potential conspiracies to rig markets in the wake of blockbuster interest-rate and currency-rigging probes that led to billions of dollars in fines and the resignation of top execs, including Barclays chief executive Robert Diamond.
Other banks, including Deutsche Bank, Royal Bank of Scotland, BNP Paribas, Morgan Stanley, and UBS, had trading and chat records subpoenaed by the Department of Justice.
In addition, the Securities and Exchange Commission and the New York Department of Financial Services were investigating the alleged rigging.
Spokespeople for the Department of Justice and the SEC didn’t return requests for comment, and a DFS spokesman declined to comment.
Wall St. Traders Secretly Used Chat Rooms To Rig Treasury Bond Prices:
Wall Street banks secretly shared client information in online chat rooms in order to rig auctions for the $14 trillion US Treasurys market, according to an explosive lawsuit filed in Manhattan federal court on Wednesday.
The move wrongly fattened the banks’ profits and picked profits from clients, the suit claims.
The new accusations, leveled by several pension funds and wealthy individual investors, are contained in an expanded class-action suit originally filed in July 2015 — and include an unusual twist: Some of the evidence came from confidential informants and one of the banks sued in the earlier action.
That bank is now cooperating with the plaintiffs in the massive civil action, and is providing an in-depth look into how Wall Street allegedly conspired to rig Treasury bond trades.
The revised lawsuit expands on details on how the banks conspired to set Treasury bond prices — like moves to manipulate the price of the bonds higher on days when there was a lot of demand, and vice versa, court papers claim.
The funds, representing retirees and public workers, also claim the banks conspired to rig the secondary Treasury markets beginning in the 1990s through tightly controlled electronic platforms that inhibited more competitive trading — a new allegation that wasn’t in the original suit but mirrors similar complaints filed against banks in other markets, like stock loans.
The amended suit tightens its focus on a select number of banks, naming Goldman Sachs, Morgan Stanley, the Royal Bank of Scotland, BNP Paribas, and UBS, among others, as the firms behind the rigging, which they allege occurred from Jan. 1, 2007, to mid-2015.
Last year, the judge presiding over the class-action suit had questioned whether the claims were strong enough to proceed.
The funds continue to allege the banks mined their own customers’ bids for Treasury bonds to get a bigger share of the auction, and sell the bonds for more profit.
Probes on the auction practices are being conducted by the Justice Department, the Securities and Exchange Commission and other federal, state and overseas regulators, sources said. No regulator has accused any bank of wrongdoing.
The banks named in the suit are primary dealers, which means they buy the debt directly from the Treasury and resell it to their clients at a pre-determined price.
Typically, the Treasury holds an auction, then banks submit their bids for US debt based on how much they think those bonds are worth. The Treasury then doles out the bonds proportionately to the bidders at the same price. The bank that asked for the best price gets the most bonds.
Traders at the Wall Street banks shared the prices that their clients had sought to buy the bonds, giving each of the banks in the alleged cartel a clearer picture of what they thought the market was, and a better chance at getting a bigger share of the bonds to sell, according to the complaint.
Details about bid prices are supposed to be a closely held secret.
Washington’s probe into the alleged rigging of the $13 trillion US Treasurys market by Wall Street banks has narrowed its focus to a handful of firms — including Goldman Sachs.
In addition, European authorities have opened their own investigation into possible Treasurys bid-rigging, sources said.
Investigators in the fraud division of the Justice Department have obtained chats and emails from Goldman that appear to implicate the company in manipulating the price of Treasury bonds, according to two sources familiar with the investigation.
Those chats and emails are being analyzed to determine if traders at other banks could be involved with any possible bid-rigging of US government debt, those two people said.
The identities of any traders in investigators’ cross hairs couldn’t be learned.
Goldman is said to be cooperating with the probe, one person said.
In June, The Post reported exclusively that Justice was in the early stages of investigating banks for rigging the price of Treasurys, the largest and most easily tradeable asset in the world.
Goldman is one of about 22 financial institutions that have been probed for any evidence that they may have manipulated Treasury auctions — a secretive process where banks and other financial services companies bid on the price of government debt, sources said.
Justice is also looking into whether there was price-rigging in the secondary market for Treasurys, where debt is sold at a premium, sources added. It’s unclear if investigators have yet found any improprieties or criminality.
Goldman, run by Chief Executive Lloyd Blankfein, is a major player in US government bond trading, and regularly submits bids for auctions.
In November, Goldman disclosed in a regulatory document that it was being probed for possible manipulation of government bond prices. Michael DuVally, a Goldman spokesman, declined to comment further.
Meanwhile, the European Commission, the law enforcement arm of the European Union, has opened its own investigation, joining Justice, the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the New York Department of Financial Services, according to two sources.
The rigging investigation is the biggest scandal to hit the quiet but crucial Treasurys market since 1990 when Paul Mozer, a former Salomon Brothers partner, illegally cornered the government debt market. Mozer’s actions are known to readers of Michael Lewis’ “Liar’s Poker.”
Traders are thought to have rigged the market in two possible ways: by agreeing beforehand to keep bond prices higher than normal in order to boost profits in other positions that depend on higher rates, similar to how banks rigged the London-based Libor rate.
Banks also could have colluded to keep prices lower than normal to sell them at a higher price — and score a bigger spread — to their clients, who agreed to pay a fixed amount beforehand.
69% Of Reissued Treasury Auctions Were Suspicious, Suit Says
Same Type Of Analysis Caught Cheating In Currencies And Libor
The same analytical technique that uncovered cheating in currency markets and the Libor rates benchmark — resulting in about $20 billion of fines — suggests the dealers who control the U.S. Treasury market rigged bond auctions for years, according to a lawsuit.
The analysis was part of a 115-page lawsuit filed in Manhattan federal court on Aug. 26 by Quinn Emmanuel Urquhart & Sullivan LLP and other law firms. The plaintiffs built their case against the 22 primary dealers who serve as the backbone of Treasury trading — including Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley — using data from Rosa Abrantes-Metz, an adjunct associate professor at New York University who has provided expert testimony in rigging cases.
Her conclusion: More than two-thirds of a certain type of Treasury auction appear to have been rigged. She found issues with other auctions, too.
“The only plausible explanation is that Defendants coordinated artificially to influence the results of the auctions in the primary market,” according to the complaint filed by the Cleveland Bakers and Teamsters Pension Fund and other investors.
The lawsuit, which seeks unspecified damages, comes as the U.S. Justice Department probes whether information in the Treasury auction market is being shared improperly by financial institutions, three people with knowledge of the investigation said in June. Treasury traders at some banks learn of customer demand hours before auctions, and were communicating with their counterparts at other firms via chat rooms as recently as last year, Bloomberg News reported earlier this year.
Abrantes-Metz’s analysis is similar to one used in lawsuits claiming bank and broker manipulation of the London interbank offer rate, or Libor. Those cases resulted in about $9 billion in settlements from the financial firms. Banks and brokers have paid about $9.9 billion in fines to global regulators related to manipulation of currency markets as of May.
Representatives of Goldman Sachs, JPMorgan and Morgan Stanley declined to comment on the Treasury lawsuit’s allegations.
The U.S. Treasury initially sells securities to the primary dealers who in turn sell them to clients, creating a secondary market for trading. Sometimes, after auctioning off debt, the government later issues an identical batch of securities — known as reissued Treasuries.
When the second set of Treasuries is issued, their prices and yields can be compared with the identical securities already trading in the secondary market. If there are pricing differences, that could be evidence of a problem. According to the plaintiffs, 69 percent of the auctions of reissued Treasuries from 2009 to 2015 appear to have been rigged, artificially boosting yields by 0.91 basis points.
The plaintiffs said there’s evidence of cheating from at least 2007 through earlier this year, when press reports revealed the Justice Department investigation into the auction process.
“These analyses reveal a consistent pattern: Treasury auction yields were artificially high (and prices correspondingly low),” according to the complaint. “Defendants then turned around and sold the Treasuries at higher prices (and correspondingly lower yields) in the secondary markets, reaping substantial profits.”
The data analysis showed similar discrepancies when prices at Treasury auctions were compared to those in the secondary market as well as the when-issued market. Treasury futures experienced similar downward pressure on prices leading up to auctions, the lawsuit claims.
Among the lawyers representing the investors is Daniel Brockett, a Quinn Emmanuel attorney who recently won a $1.87 billion settlement against Wall Street’s largest banks in a case alleging they conspired to limit competition in the market for credit-default swaps.
Brockett said in an interview that the new lawsuit alleges the artificially low auction prices grew in direct proportion to how many primary dealers were involved in an auction.
“No matter which way you measure it, they end up benefiting in ways that wouldn’t otherwise be possible in a liquid market of this size,” he said. The $12.8 trillion Treasury market helps sets interest rates on everything from home mortgages to credit cards and is often described as the largest, most-liquid market in the world.
Another group of investors, including Boston’s public employee retirement system, has filed a similar suit against Wall Street primary dealers. Experts interviewed by Labaton Sucharow LLP, the law firm that filed that suit, analyzed auctions and the market for when-issued securities, which are essentially agreements to buy or sell Treasury bonds, notes or bills once they’re issued.
They claim that banks colluded to push prices artificially low at auctions, and to drive prices for when-issued securities to artificially high levels, until December 2012, when news broke of investigations into how Libor was set.
“These scenarios all turn on a very simple conflict of interest,” attorney Michael Stocker said in a telephone interview. “You had banks who were auction participants who also had the power to move the prices that those markets depended on.”
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A Justice Department spokesman didn’t return an email seeking comment, while EC spokesman Ricardo Cardoso declined to comment.
Each bank declined to comment on the lawsuit after it was first filed.
Regulators Ask Banks About Preparations for Libor’s Demise
Banks must show how they are managing risks stemming from the planned end of the benchmark rate next year.
Financial regulators are asking banks to show they have plans in place to manage the risks stemming from the planned demise of a key benchmark interest rate.
Regulators, which for months have urged banks and other financial services firms to prepare for the likely end of the London interbank offered rate in 2021, have recently begun asking for evidence of their preparations.
The New York State Department of Financial Services is requiring banks and insurers to submit plans for managing the risks associated with the end of Libor, the agency said in a letter last week. The Office of the Comptroller of the Currency, which oversees national banks, said in December that it plans to increase oversight of the issue and that examiners will evaluate whether banks have made an inventory of all contracts that could be affected.
The Federal Reserve’s supervisors have also begun asking banks about their plans, Vice Chairman for Supervision Randal Quarles said in June. The Federal Deposit Insurance Corp. declined to comment.
“They are all making similar noises: ‘We need you to pay attention. It is important. It isn’t going to go away,’ ” said Paul Forrester, a partner at law firm Mayer Brown LLP who focuses on corporate finance and securities.
Global banks face a particularly thorny challenge in moving away from Libor because they need to take into consideration the range of alternative rates that could be used in currencies across the world, Mr. Forrester said.
Major banks have made progress in preparing for the transition, according to Dan Stipano, former deputy chief counsel at the OCC. However, the coming transition to an alternative rate is rife with legal and operational risks for the industry, lawyers said.
“They need to give themselves a lot of lead time,” said Mr. Stipano, who is now a partner at Buckley LLP.
Banks Brace For ‘Big Bang’ Switch On $80 Out $200 Trillion Worth of Swaps
The big bang is one of the most important steps in the Libor transition to SOFR.
It’s being called the “big bang,” and it has derivatives traders on high alert.
In a critical development in the global shift away from old benchmarks that was triggered by Libor’s shortcomings, interest-rate swaps on more than $80 trillion in notional debt will transition this weekend to a new rate for determining their value.
While the switch to the secured overnight financing rate, or SOFR, is expected to boost longer-term liquidity in the new benchmark, it also is fueling concerns about unruly price action because it is expected to trigger the sale of swaps on tens of billions of dollars of debt.
“The big bang is one of the most important steps in the Libor transition,” said Marcus Burnett, director of SOFR Academy, an education technology firm whose clients include banks and asset managers. “We expect rates desks from the largest banks in New York to be participating.”
The reset, which will see SOFR replace the effective federal funds rate in calculations that value swaps, is part of a push to make SOFR a standard U.S. reference rate in debt and derivatives markets. SOFR is intended to replace dollar Libor, which still underpins hundreds of trillions of dollars of assets such as mortgages in the U.S. and syndicated loans in Asia.
The big bang follows a smaller-scale pivot in Europe this July, a less-complicated switch that occurred without much impact on the market.
Interest rate swaps allow two parties to trade one stream of payments for another, over a set period of time. The most common variety, known as a vanilla swap, involves exchanging payments from a fixed rate for payments from an adjustable rate that is based on Libor or some other reference rate. Another kind, known as a basis swap, involves two adjustable rates.
While SOFR has struggled to gain traction since its introduction in 2018, analysts say the upcoming big bang has already triggered a shift toward more trading in SOFR-linked swaps.
This could help pave the way for a curve that reflects expectations for where the rate will be in the future, addressing one of the new benchmark’s key weaknesses.
The big bang “will have a very, very good impact on liquidity,” said Jason Granet, chief Libor transition officer at Goldman Sachs Group Inc.
Still, in the immediate future there will be turbulence in pricing. Clearing houses are planning to effectively neutralize the changes in swap values caused by the big bang, and traders will see their positions automatically adjusted. LCH Ltd. and CME Group Inc. are preparing to distribute compensation from clients whose position values go up to those who see them decline.
LCH will facilitate payment of hundreds of millions of dollars in cash to cover lost value, and at least tens of billions of dollars in basis swaps to compensate for risk, said David Horner, head of risk at SwapClear, which is part of LCH.
However, some firms do not use basis swaps to hedge their discount-rate risk or are otherwise incapable of keeping them on their books, so they are expected to sell them. This Friday LCH will hold auctions in which 18 banks can close out $25 billion in unwanted basis swaps.
Buyers, ideally, would snap them up either as hedges against risk or for their own value. But the approach is largely untested since basis swaps were not distributed in the European version of the big bang.
“For about six months our members and clients have been able to look on their screens and see a forecast for the compensating cash payments and compensating swaps they will receive, so they are familiar with what’s about to happen,” said Horner. “It’s important for the market that it runs smoothly.”
CME will hold a similar auction on Monday. Clients have agreed to a maximum loss, said Sunil Cutinho, president of CME Clearing, and “if their positions cannot be auctioned off then they are fully protected and they can use their own private means to dispose of their positions.”
However, there are concerns about price swings in the market amid a surge in supply as some banks ditch basis swaps they received as compensation.
The big question is how well the auctions go. Clearing houses are not guaranteeing the minimum prices for the basis swaps, which could fall below the maximum that firms are prepared to tolerate, said Joshua Younger, a strategist at JPMorgan Chase & Co.
“Many would then likely unwind them in the open market and the price action could get very disorderly,” he said.
Firms need to understand they are facing more risk from this change first before they eventually get less risk, said Pieter Van Vredenburch, a principal at Market Alpha Advisors and previously a member of the Alternative Reference Rates Committee, which is guiding the U.S. Libor transition, when he worked for HSBC Holdings Plc in 2016.
“The big banks are very prepared for the big bang,” said Van Vredenburch. “But do I think the smaller banks are ready for this? Not even close.” When it comes to the overall switch to SOFR, he said, “there are so many nuances to the transition and the devil is in the details. There is nothing simple in all this.
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Finance Executives Look To Advance Libor Transition In 2021
The interest-rate benchmark is being phased out, forcing companies to update contracts and adjust funding projections.
Efforts to skip the London interbank offered rate for new transactions by end of next year are forcing finance executives to take stock of their contracts, communicate with banks and investors and adjust their interest-rate cost calculations.
Global policy makers decided to do away with Libor, an interest-rate benchmark underpinning trillions of dollars worth of financial instruments, after concluding it was prone to manipulation. Banks face a Dec. 31, 2021, deadline to replace Libor with alternative rates for new contracts following a yearslong transition effort.
A majority of financial and nonfinancial companies recently said their Libor transition plans are ahead of schedule, according to a survey by consulting firm Accenture PLC released earlier this month. In some cases though, the pandemic has caused delays.
Corporations including Walt Disney Co. , network-equipment maker Juniper Networks Inc. and cancer treatment firm Varian Medical Systems Inc. have started alerting investors to the pending changes and the potential challenges as they shift to a new rate regime.
Businesses face potential adjustments to interest costs, arising from Libor being calculated differently than its likely successor in the U.S., the Secured Overnight Financing Rate, or SOFR.
For one, the immediate cost of borrowing may be cheaper. While Libor is derived from daily price quotes provided by a panel of banks, SOFR is based on the cost of transactions in the market for overnight repurchase agreements, or repos. Financial companies already use the repo rate to borrow cash, using U.S. government bonds as collateral. SOFR is considered a less risky rate, which means overall interest costs for companies could be lower than under Libor.
But SOFR currently doesn’t allow for predictive, forward-looking rate calculations, a notable deviation from Libor, which can be calculated three, six or 12 months out. This limits the insight treasurers can glean into future interest-rate costs.
Timken Co. ’s Chief Financial Officer Philip Fracassa is working to ensure that the North Canton, Ohio-based maker of engineered bearings and power-transmission products shifts its contracts to SOFR. “The discontinuation of Libor requires a lot of restructuring of debt agreements,” Mr. Fracassa said.
He doesn’t expect big changes to Timken’s interest costs as part of the transition, but foresees additional paperwork, including updating contracts and policies. “There’s a lot that you’ve got to do,” he said.
Finance executives also need to deal with existing contracts that cite Libor. That can be tricky—especially in cases where some of these debt instruments are held by hundreds of investors who all need to agree to the changes. Transaction lawyers suggest that finance chiefs create an inventory of agreements that reference Libor, and take a look at when they run out and who the other party is. The cut-off date for existing contracts to stop referencing Libor is June 30, 2023.
“The issue for treasurers and CFOs is managing the transition across the whole company,” said Michele Navazio, a partner at law firm Seward & Kissel LLP. “It is not going to happen simultaneously, which could add to the complications.”
Serena Wolfe, CFO at Annaly Capital Management Inc., a New York-based mortgage real-estate investment trust, hopes legislators will make it easier for companies to deal with some of these legacy contracts. A potential fix for certain residential credit securitizations currently is being debated by New York state lawmakers.
Annaly Capital has a Libor working group, which found that recent upgrades to the company’s technology systems will make it easier to manage the data required to transition away from Libor, Ms. Wolfe said. Other companies, especially those still relying on manual data entry and Microsoft Excel, could find that harder, she said.
Dealing with two benchmark rates—SOFR for new contracts after Dec. 31, 2021, and Libor for legacy contracts until June 30, 2023—won’t be a problem for Annaly Capital, Ms. Wolfe said, adding that the company already holds swaps which cite different rates.
For some businesses though, the dual rates will present a challenge, said Venetia Woo, lead Libor adviser at Accenture. “Corporates now have two expiration dates for Libor contracts and they need to determine if the economics to convert [by year-end] outweigh the burden of running two operations,” she said.
Libor Proving Hard To Kill In $200 Trillion Derivatives Market
It’s one of the most confounding questions facing regulators in the fight to phase out the London interbank offered rate.
How do you wean everyone from asset managers and traders to corporate treasurers off derivatives that are so ubiquitous, they’ve become part of the fabric of the financial system?
For the better part of three years, U.S. officials have been preaching patience. Libor-based interest-rate swaps, futures and options, among the most liquid markets in the world, would gradually give way to new securities tied to new benchmarks, they said, including the Secured Overnight Financing Rate, dollar Libor’s anointed successor.
Yet activity in those markets isn’t disappearing. What’s more, acceptance of alternative products has been slow. While some headway has been made, average open interest in three-month SOFR futures barely topped 5% that of eurodollar contracts last month. And recent high-profile milestones in the Libor transition that were expected to jump-start trading in the new instruments have delivered relatively modest boosts so far.
As the Federal Reserve’s year-end deadline to halt new Libor contracts creeps closer, some are beginning to express concern that the slow pace of progress could undermine efforts to ensure a smooth transition, posing a risk to financial stability.
While few expect a delay similar to the one announced in November for legacy contracts that can’t be shifted to SOFR, it’s another example of the difficulties regulators have had in getting critical corners of the financial world on board.
“We’re in this classic chicken-and-egg scenario, where participants don’t want to trade because liquidity is low, but there’s not going to be enough liquidity unless people trade it,” Thomas Pluta, global head of linear rates at JPMorgan Securities, said of SOFR derivatives. “It’s increasing, but quite frankly there’s an awful lot more that needs to be done for this transition to happen.”
More than $200 trillion of financial instruments globally are tied to dollar Libor, with the vast bulk of that exposure in the form of derivative contracts, according to the Bank for International Settlements. The products are used by money managers to bet on the direction of monetary policy and corporations to hedge their interest-rate exposure.
Some market watchers predict the shift to SOFR derivatives will ramp up in the coming months after the Fed made clear late last year that it still expects banks and other regulated firms to stop entering into new Libor-based transactions by the end of 2021.
“That will force the issue quite a bit,” said Tyler Wellensiek, a managing director in rates sales at Barclays Plc. Nonetheless, she acknowledged that “there’s definitely a lot more work to do in SOFR liquidity.”
Officials at the Alternative Reference Rates Committee — the Fed-backed group tasked with overseeing the Libor transition in the U.S. — point to the gradual increase in SOFR activity across the swaps curve since the middle of last year as evidence that the benchmark is gaining traction among derivatives traders.
“The depth of liquidity has improved a lot,” said Tom Wipf, ARRC chair and a vice chairman of institutional securities at Morgan Stanley.
Add to that another potential boost in activity in the coming months with the setting of the International Swaps and Derivatives Association’s spread adjustment — used to determine fallback rates for Libor contracts maturing after the benchmark is phased out — and SOFR’s proponents see reasons to be encouraged.
Still, there’s no guarantee the fixing of the spread adjustment will spark a surge in trading.
Other recent milestones in the Libor transition, including the so-called big bang shift by derivatives exchanges to SOFR for calculating the value swaps, and ISDA’s publication of a highly anticipated legal protocol to help convert Libor-linked contracts to SOFR, have produced relatively fleeting boosts so far.
Just 5.6% of all U.S. dollar risk in cleared over-the-counter and exchanged-traded interest-rate derivative transactions was tied to SOFR in November, according to data from ISDA and Clarus Financial Technology. While that’s almost double the 3% of trading activity that referenced the rate in June, it’s well off the record 9.7% reached in October, when global clearing houses made the shift to SOFR.
JPMorgan’s Pluta said he had expected the big bang to be “a catalyst for lots of different market participants to start trading SOFR actively,” but “many participants just did what they needed to do, and then reverted for the most part to Libor.”
Should the shift to SOFR derivatives struggle to gain pace in 2021, it could delay the ARRC’s ability to develop a forward-looking term reference rate, according to Marcus Burnett, the director of SOFR Academy, an education technology firm whose clients include banks and asset managers.
That may in turn discourage underwriters and issuers in the loan market from pricing new deals based off of the alternative benchmark.
“Without that, it’s less likely that we’re going to have a robust liquid and institutional-sized lending market based on SOFR,” Burnett said. “Without the lending market, we can’t have a broad-based transition.”
Some are already concerned that it could threaten the orderly functioning of markets.
“On some level it has to have implications for financial stability because of the uncertainty it generates,” Anne Beaumont, a partner at law firm Friedman Kaplan Seiler & Adelman in New York, said of SOFR’s modest progress so far. “You’re already going to have this fragmented world of new instruments linked to SOFR and legacy ones that rely on fallbacks.”
While recent jumps in SOFR trading that coincided with transition milestones have proven that banks can scale up their execution, the data suggest many likely aren’t seeing significant demand from clients for SOFR transactions and risk management, according to Chris Barnes, a senior vice president at Clarus.
SOFR still needs to gain significant traction to ensure a smooth transition, he said, especially with the possibility looming that the Fed will limit trading of Libor-linked derivatives in less than a year.
“Twelve months is an incredibly short period of time to try and change the precise product that people are trading,” Barnes said. But “if we as a market, as an industry can’t get behind a change in four years, that’s not a great sign.”
Libor Is Going Away For Real
Libor Is Canceled
I Guess They Were Serious About That, Huh:
* Regulators kicked off the final countdown for the London interbank offered rate Friday, ordering banks to be ready for the end of a much maligned benchmark that’s been at the heart of the international financial system for decades.
* The U.K. Financial Conduct Authority confirmed that the final fixings for most rates will take place at end of this year, with just a few key dollar tenors set to linger for a further 18 months.
Here is the FCA’s announcement, and here is one from Intercontinental Exchange Inc., which actually administers Libor.
And here are two announcements—“LIBOR Cessation and the Impact on Fallbacks” and “ISDA Statement on UK FCA LIBOR Announcement”—from the International Swaps and Derivatives Association, which administers the market for interest rate derivatives.
One thing that is happening here is that ICE will stop calling up banks every day and asking them “at what rate can you borrow unsecured from other banks” and then using their answers to calculate Libor. That’s what ICE does now, and what the British Bankers’ Association did before ICE. It has become an increasingly untenable way to calculate an interest-rate benchmark, insofar as:
(1) the banks were lying about their borrowing costs for a while and
(2) the interbank unsecured funding market is a lot less robust than it was back before the financial crisis, so it’s hard to answer that question truthfully even if you’re trying to. So, at the end of the year, it will mostly stop, though it will keep going for the main tenors of U.S. dollar Libor until June 2023.
Another thing that is happening here is that ICE will stop publishing Libor, sort of. Actually it will keep publishing some Libor rates for a while after it stops collecting them, though with an asterisk. (The asterisk says that the new Libors will not be “representative.”)
They will be “synthetic” Libor: Instead of being based on a poll of banks’ borrowing costs, the new rates will be computed based on “a forward-looking term rate version of the relevant risk-free rate plus a fixed spread aligned with the spreads in ISDA’s IBOR fallbacks.”
In the U.S., for instance, Libor is supposed to be replaced by SOFR, the Secured Overnight Financing Rate, a risk-free rate based on the cost of borrowing secured by U.S. Treasuries. When Libor is replaced by “synthetic Libor,” the synthetic Libor will be:
(2) compounded in arrears to get a term rate,
(3) plus a spread.
The spreads are based on the historical differences between Libor and the relevant risk-free rate; here they are. 1 So for instance when ICE stops polling banks for 3-month U.S. dollar Libor, 3-month dollar “synthetic Libor” will just be SOFR, compounded for three months, plus 0.26161%.
I have written before that Libor is a “function call”: You write in a contract that the interest rate will be Libor, and then you go and pull Libor in from ICE (or from a Bloomberg page that gets it from ICE), and you don’t really care about the guts of how ICE calculates Libor. Right now ICE calculates Libor through this rickety mechanism of calling up banks and asking them to make up numbers.
In the future it will calculate Libor by looking at published risk-free rates—which benchmark administrators calculate by looking at real transactions in secured funding markets—and adding a number to them.
In theory Libor could just keep going forever, in this vestigial way: The “real” benchmark would be SOFR or whatever, and then Libor would just be a minor arithmetic manipulation of SOFR, SOFR plus 0.26%. You could still write loans or derivatives that reference Libor, and everyone would know that “Libor” is a weird archaism for “SOFR plus 0.26%.”
But The Regulators Don’t Want That Either:
* The BOE will hold executives to account for progress in the transition under the U.K.’s regulatory regime for senior managers, according to people familiar with the matter. If firms fail to take appropriate steps, there is the potential for measures such as capital sanctions, though these would come further down the line.
* Progress toward replacement benchmarks, such as the Secured Overnight Financing Rate in the U.S. and the Tokyo Overnight Average Rate in Japan, has been sluggish, and there are hopes Friday’s announcement could accelerate the process — particularly in the vast global derivatives market. …
* The Fed, for its part, is intensifying its scrutiny of banks’ efforts to shed their reliance on Libor, and has begun compiling more detailed evidence on their progress.
* “In the months ahead, supervisors will focus on ensuring that firms are managing the remaining transition risks,” said Randal Quarles, vice chair for supervision at the Federal Reserve Board and chair of the Financial Stability Board.
We’ve had several years now of regulators saying “you have to stop using Libor,” and Libor is still pretty popular, but maybe this will do it. I wonder if old-school bankers will cling to Libor in a sort of hipsterish way.
Maybe the senior banker will say “ah yeah their term loan is at Libor plus 50” and the analyst will be confused and go back to her desk and ask the associate “hey what does Libor plus 50 mean” and the associate will be like “it means SOFR plus 76, that’s just how people talk sometimes.”
Why Won’t Libor Die? It’s Complicated
The broken interest rate benchmark still dominates derivatives trading. Regulators may need to be more forceful in persuading banks to drop it.
The funeral dates for Libor are finally set, with some sensible concessions that keep part of the suite of interest rates alive for longer than initially planned. Those exemptions must be strictly controlled so as not to impede a much broader acceptance of the replacement benchmarks. For now, that’s proving harder than even those most resistant to change might have expected. So market regulators need to step up efforts to force bankers and financiers to embrace Libor’s successors.
The London interbank offered rates fell into disrepute for being easily rigged by the traders charged with submitting borrowing costs. Plus, the underlying wholesale funding market they’re based on melted away during the global financial crisis. In mid-2017, the U.K.’s Financial Conduct Authority said they’d be phased out by the end of 2021.
Since then, different alternatives have been created for different markets. In dollars, the replacement rate is the Secured Overnight Financing Rate, known as SOFR. In the U.K. markets, it’s the Sterling Overnight Index Average, dubbed Sonia. But the switch has been very, very slow, increasing the risk that a last-minute scramble to adapt to the changeover could lead to unwanted and potentially costly market distortions.
Just 10% of the total risk in the global market for interest-rate derivatives was tied to the replacement rates in both December and January, according to figures compiled by the International Swaps and Derivatives Association. Although the 2020 monthly average of 7.8% was an improvement on 2019’s 4.7%, the percentage peaked at 11.6% in October.
Those figures mask important regional differences. In the year ended Feb. 26, the notional value of trades in dollar-denominated interest-rate derivatives tied to Libor was more than $20.8 trillion, dwarfing the $472 billion that referenced SOFR, according to ISDA data. U.S. swap traders still haven’t kicked their Libor addiction. But figures for January suggest the U.K. regulator’s efforts to encourage sterling traders to switch to the new interest-rate flavor are showing signs of success.
Even in sterling, though, the most active market remains beholden to Libor. Just 20% of the risk traders took in three-month interest-rate futures was connected to Sonia rather than Libor in January, according to Intercontinental Exchange Inc.
Beyond the excuse of inertia, the market’s caution in adopting the new benchmarks is understandable. The replacement rates are based on overnight lending, which has made it tricky to calculate the matrix of different maturities to match Libor.
Moreover, speculation that some of the more important rates might get a stay of execution proved correct. While the bulk of the Libor spectrum will be phased out at the end of this year, the key one-, three-, six- and 12-month dollar rates will survive until mid-2023, allowing the bulk of existing financial contracts to mature without needing to be changed. That’s a smart concession to market reality.
The FCA estimates the value of outstanding financial contracts that still reference Libor is about $260 trillion, with cleared interest-rate swaps and exchange-traded derivatives accounting for about 80% of that total. The figure, though, excludes the bond, loan and mortgage markets.
And those are where life gets trickier. The FCA is considering allowing synthetic Libors — based on the new rates but adjusted for maturity and with an added credit spread — to take the contractual place of the current rate in contracts that can’t easily be switched to the replacement benchmarks. It’s a legal sleight of hand that slides the new borrowing costs into existing contracts, covering hard-to-adjust legacy documentation that might not even surface until after Libor’s demise.
But regulators should take a hard line on restricting what qualifies for that special treatment, otherwise firms will have an excuse not to make the change and Libor will linger on indefinitely. Banning new contracts from referencing Libor was a good start, but forcing banks and insurers to list their exposures to the old benchmark by category would do wonders.
It would focus attention on the need to revise the terms of those trillions of dollars of outstanding obligations. Goldman Sachs Group Inc. for example, said this week that it’s still deciding how to deal with about $29 billion of Libor-linked bonds and preferred shares that run past Libor’s expiry date.
With the FCA’s final timetable for Libor’s endgame, regulators will be hoping the pace of adoption of the new reference rates accelerates. If it doesn’t, more stick might be needed to shift market players out of the status quo. Enlightened self-interest would suggest it’s time to euthanize Libor.
Libor Wall Street Fix Gets A Boost As N.Y. Senator Backs Move
A key New York state lawmaker is supporting legislation intended to protect hundreds of billions of dollars of contracts from legal chaos when Libor is phased out as an interest-rate benchmark, marking a potentially crucial step toward securing its passage.
Democrat Senator Liz Krueger, the head of the finance committee, said in an interview that she is in favor of provisions contained in Governor Andrew Cuomo’s proposed budget that would allow existing contracts to use replacement indexes recommended by regulators. She said failing to enact that could give large companies power to impose their own changes instead, potentially to the peril of consumers.
Bankers, investors and regulators see such proposals — which will help troublesome Libor-linked contracts switch to replacement rates — as crucial to ensuring that a large swath of the global financial system isn’t disrupted.
Krueger’s support matters because she previously challenged similar reforms proposed by the Alternative Reference Rates Committee, the Federal Reserve-backed body guiding the transition, on the grounds that they could put retail consumers at a disadvantage.
Krueger said in the interview that she has thoroughly examined the plan in Cuomo’s budget and concluded it is “legitimate” and adequately protects consumers. The deadline for passing the budget is April 1.
“It still needs to be negotiated,” she said, adding that she’s hopeful it will make it into the final budget.
While most Libor indexes will be retired at year-end, various tenors of the dollar-denominated benchmark may be given a reprieve from the phase out until mid-2023, in part to allow older contracts that lack a clear replacement rate to expire naturally.
While that would help reduce the threat to financial stability, the most challenging floating-rate debt and securitizations — as well as Libor-based mortgages and student loans — will be in place after Libor is no longer used, making legislation critical.
Backing from the committee head makes the law more likely to pass, according to Priya Misra, global head of interest rate strategy at TD Securities and a member of the ARRC, the Fed-backed transition planning group.
“We are down to the wire with the New York state legislation and it is extremely important to address the problem of legacy cash products with inappropriate fallback language,” she said. Passing the law “would be a win-win since it helps bring clarity for issuers and investors.”
Tom Wipf, vice chairman of institutional securities at Morgan Stanley and chairman of the ARRC, said the body “welcomes all support for the legislation, which is essential to providing legal certainty and financial stability.”
Lawyers say even if the law passes, separate legislation is likely to be needed to protect sections of the market that fall beyond Wall Street. Federal Reserve Chair Jerome Powell said in February that national legislation would be the best solution.
“Once you have legislation in New York, you have a template that other states can piggy back off and hopefully even have a federal legislative solution,” said Y. Daphne Coelho-Adam, a counsel at Seward & Kissel LLP. “It gives everyone ability to look forward without hitting that wall or going off a cliff.”
Libor Enters ‘Final Chapter’ As Global Regulators Set End Dates
Regulators kicked off the final countdown for the London interbank offered rate Friday, ordering banks to be ready for the end of a much maligned benchmark that’s been at the heart of the international financial system for decades.
The U.K. Financial Conduct Authority confirmed that the final fixings for most rates will take place at end of this year, with just a few key dollar tenors set to linger for a further 18 months.
The move comes in the wake of major manipulation scandals and the drying up of trading used to inform the rates, which are linked to everything from credit cards to leveraged loans. Global regulators have made a concerted effort to wind down the benchmark in 2021, with the Federal Reserve and others pushing market participants toward a slew of alternatives.
“Outside the U.S. dollar markets, this marks the end game,” said Claude Brown, a partner at Reed Smith LLP in London.
“The rate that linked the world, and then shocked the world, will leave this world in 2021.”
Libor is deeply embedded in financial markets. Some $200 trillion of derivatives are tied to the U.S. dollar benchmark alone and most major global banks will spend more than $100 million this year preparing for the switch. Other players — from corporations to hedge funds — will also be affected, with many only beginning to shift from legacy contracts.
Bank of England Governor Andrew Bailey said this was now the “final chapter,” and there’s no excuse for delays.
The BOE will hold executives to account for progress in the transition under the U.K.’s regulatory regime for senior managers, according to people familiar with the matter. If firms fail to take appropriate steps, there is the potential for measures such as capital sanctions, though these would come further down the line.
Progress toward replacement benchmarks, such as the Secured Overnight Financing Rate in the U.S. and the Tokyo Overnight Average Rate in Japan, has been sluggish, and there are hopes Friday’s announcement could accelerate the process — particularly in the vast global derivatives market.
“This was the much anticipated final piece of clarity the market needed to really kick on,” said Kari Hallgrimsson, co-head of EMEA rates at JPMorgan Chase & Co. “We would expect liquidity for trading the new rates to keep increasing from here on out.”
Friday’s decision is a cessation event and locks in the benchmark’s fallback spread calculations, which for dollar Libor will be added to SOFR, the main U.S. replacement. Where firms have adhered to International Swaps and Derivatives Association’s Libor protocol, their contracts will automatically transition to replacement rates the moment Libor ends, avoiding a cliff-edge scenario.
The delay in the most-used dollar Libor tenors — notably the three-month benchmark — is a concession to market concerns, but regulators remain adamant that dollar Libor shouldn’t be used for new contracts after 2021. Firms should expect further engagement from their supervisors to ensure timelines are met, the FCA warned.
The Fed, for its part, is intensifying its scrutiny of banks’ efforts to shed their reliance on Libor, and has begun compiling more detailed evidence on their progress.
“In the months ahead, supervisors will focus on ensuring that firms are managing the remaining transition risks,” said Randal Quarles, vice chair for supervision at the Federal Reserve Board and chair of the Financial Stability Board.
While speculation about the announcement’s timing jolted the eurodollar market in December, the market reaction on Friday was subdued. The spread between June 2023 and September 2023 Eurodollars widened one basis point, as did the difference between December 2021 and March 2022 short sterling contracts.
The FCA also detailed proposals to deal with the most troublesome loans and securitizations that can’t be switched to replacement rates. The regulator will consult on synthetic Libor — which doesn’t rely on bank panel data — for the sterling and yen benchmarks, and will continue to consider the case for using these powers for some dollar Libor settings.
Worries are mounting that hundreds of billions of dollars of these legacy contracts will never be able to transition, even with the extension of certain dollar Libor tenors. This will present a key challenge to banks, regulators and lawmakers in the months ahead.
“Some cash products have not embraced Libor and the clock is ticking loudly,” said Priya Misra, global head of interest rate strategy at TD Securities. “A lot of them will mature by June 2023, but there will be a lot left over after that.”
HKMA Delays A Target For Phasing Out Libor Products To End-2021
The Hong Kong Monetary Authority has pushed back a target for banks to phase out certain products tied to the London interbank offered rate, according to a statement Thursday.
HKMA said that the so-called milestone for banks to cease issuing new Libor-linked products that will mature after 2021 will now be the end of this year. That’s a shift from the previous goal of the end of June.
HKMA said it and the Treasury Markets Association agreed that it’s no longer appropriate to stick to the end-June deadline partly in light of feedback from banks. The HKMA added that authorized institutions should press ahead with their transition preparations.
Global regulators are driving the shift to alternative risk-free rates to replace Libor, which was tainted by a rate-rigging scandal but still underpins hundreds of trillions of dollars worth of financial assets.
The latest change will more closely align Hong Kong’s schedule with a similar timetable in the U.S., where authorities have asked banks to stop entering new contracts based on U.S. dollar Libor after the end of 2021. Last year, the ICE Benchmark Administration Ltd., which is the administrator of the dollar benchmark, also said it was looking to push back the timeline for abandoning some of the discredited interest-rate settings to mid-2023.
N.Y. Governor Signs Libor Fix Into Law To Avert Transition Chaos
New York Governor Andrew Cuomo late Tuesday signed into law a measure that will help prevent hundreds of billions of dollars of financial contracts from descending into chaos when the London interbank offered rate starts phasing out at the end of the year.
The measure, passed by the state Senate and Assembly last month, would allow existing contracts to use replacement indexes recommended by regulators.
The New York law establishes that the recommended benchmark replacement is a “commercially reasonable substitute for and a commercially substantial equivalent to Libor” and that using the recommended benchmark replacement “provides a safe harbor from litigation.”
While most Libor indexes will be retired at year-end, various tenors of the dollar-denominated benchmark may be given a reprieve from the phase-out until mid-2023, in part to allow older contracts that lack a clear replacement rate to expire naturally. While that would help reduce the threat to financial stability, the most challenging floating-rate debt and securitizations — as well as Libor-based mortgages and student loans — will be in place after the benchmark is no longer used.
Almost $2 trillion of debt pegged to dollar Libor won’t mature until after the discredited rate expires in mid-2023, according to the Alternative Reference Rates Committee, the Federal Reserve-backed group guiding the transition.
Federal legislation may still be needed. Fed Chair Jerome Powell said last month that national legislation is necessary to ensure a smooth transition.
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