LIBOR Transition: Expert Views – Maria Daniels

“For firms who haven’t begun transitions yet, whilst there is a shortened timeframe, having a clear plan with defined objectives, timescales and tolerances is essential.”

Maria Daniels

UK liability-driven investment (LDI) asset managers were some of the first to transition sterling London Inter-bank Offered Rate (LIBOR) portfolios to Sterling Overnight Index Average (SONIA). Could you describe how you approached the transition?

We had a clearly-defined transition plan with key objectives, investment principles, market tolerances and timeframes. This allowed for flexibility to take advantage of market liquidity and act swiftly to market axes, thereby reducing transaction costs and expediting the program. The transition was split into several phases with respect to risk management and was managed across all clients ensuring Treating Clients Fairly (TCF) was achieved across all portfolios.

Trade structuring and the ability to facilitate trading via both bilateral and cleared routes played a key role in managing complex portfolio structures and allowed us to take advantage of both inter-portfolio and cross-portfolio offsets across the whole BlackRock franchise, further reducing transaction costs for our clients. The LDI portfolio-management team worked closely with the BlackRock trading team to ensure smooth and efficient execution, limiting market impact and ensuring readiness to take advantage of market opportunities as they arose.

How have you found liquidity in the SONIA derivatives market since transitioning your portfolios? Are there any products in which liquidity is harder to find than it was in sterling LIBOR?

As part of our portfolio-management process, we monitor liquidity and transaction costs across SONIA and LIBOR products, and transaction costs for SONIA swaps have cheapened as the market has shifted from LIBOR and SONIA swaps have become more liquid. With the transition of the inter-bank market to SONIA as default on 27 October 2020, this further shifted the market towards SONIA swaps.

In terms of products where liquidity can be harder, whilst the swap transition is well progressed, non-linear instruments such as swaptions, as well as cross-currency swaps, are slightly behind in their journey. SONIA is what most long-term clients want to trade; it’s the default in the interbank market and offers better liquidity and cheaper transaction costs, so active accounts use it for duration views. With additional support from the regulatory tailwinds to transition, its dominance over LIBOR is entrenched.

“LIBOR is something that permeates across many different areas. The co-ordination across these groups is something that all firms should focus on to ensure smooth transition.”

Maria Daniels

Now we have the LIBOR cessation/non-representativeness statement from the FCA, do you feel we will see a significant pick-up in active portfolio transitions across asset managers?

The cessation statement is another helpful step on the journey, although given it was expected by the market, and we’d already seen other significant catalysts (the ISDA Protocol; SONIA becoming the inter-bank default; steps to transition in other sectors like insurance, etc.), we are already well on the journey with many proactive market participants already having progressed through transitions.

What advice would you give to firms who are yet to start active portfolio transitions to RFRs?

For firms who haven’t begun transitions yet, whilst there is a shortened timeframe, having a clear plan with defined objectives, timescales and tolerances is essential. Whilst being flexible enough to adapt to pockets of market liquidity that emerge will help to manage transaction costs and allow for expedited completion of programs, it is also important to be thorough in consideration of all implications of the transition – market conditions, operational readiness and legal due diligence are all important to consider.

Our experience is that if such an approach is taken, even complex portfolios can be transitioned quickly and smoothly. LIBOR is something that permeates across many different areas and our working groups on LIBOR transition have comprised of representatives from numerous groups including trading, portfolio management, legal, operations and compliance. The co-ordination across these groups is something that all firms should focus on, to ensure smooth transition, with all implications considered.

What would you say is the biggest obstacle firms are facing as they prepare for the transition away from LIBOR?

There are obvious considerations that LIBOR is deeply entrenched in some markets, which has complicated the transition. We also have the further consideration of the impact of regulation in certain sectors. These factors can add to the challenges in the transition away from LIBOR. In addition, for some smaller market participants, it’s logistically and operationally challenging to manage the transition. Firms need to ensure that all parts of the operational chain can facilitate the fallback. Another consideration would be that, given the phased approach across the different markets – e.g. the U.S. dollar and sterling not transitioning at the same time – this has further implications for instruments that cross these markets, e.g. the use of cross-currency swaps. The additional cost of not transitioning would be holding LIBOR instruments with declining liquidity.