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  • New US Dollar Libor Deadline Doesn’t Guarantee a Smooth Transition

    December 23, 2020 by Fitch Ratings

    Fitch Ratings-New York/London-01 December 2020: Pushing the Libor transition deadline for the U.S. dollar (USD) market back 18 months would lessen the risk of disorderly outcomes at YE21 but using this extra time productively is the key to a smooth transition, Fitch Ratings says. Primary markets have yet to shift to alternative indices, regulators and legislators might need to facilitate orderly transition for hard-to-fix legacy contracts and liquidity needs to develop in derivatives based on the Secured Overnight Financing Rate (SOFR).

    ICE Benchmark Administration Limited (IBA) on Monday announced a consultation that could see the cessation of the widely used one-, three-, six- and 12-month USD Libor reference delayed to end-June 2023. IBA will also consult on ceasing publication of one-week and two-month USD Libor at end-2021, in line with the original timetable.

    Additional preparation time should avoid the potential operational and market disruption if all USD Libor settings ceased publication after 31 Dec 2021. As we have previously noted, delays in creating a robust SOFR-based derivatives market and the failure to develop a SOFR term rate sufficiently far in advance of cessation could materially increase risks to financial institutions arising from transition, while legacy Libor exposure is significant, particularly in structured finance.

    The IBA consultation appears part of a coordinated effort by regulators to avoid such disruption. The UK Financial Conduct Authority (FCA), which regulates IBA as Libor’s administrator, and the Federal Reserve Board (the Fed) both welcomed the prospect of ‘a clear end-date’ for USD Libor that left enough time to deal with legacy contracts where amending fallback language remains difficult, partly by reducing the number of affected contracts as most of these would mature before cessation. The backing of U.S. and UK regulators illustrates the magnitude of the transition challenges facing USD market participants.

    Addressing legacy contracts also depends on moving primary market activity from USD Libor to SOFR or other alternative indices. SOFR adoption has been uneven and lagged other markets (sterling issuance largely references the Sterling Overnight Index Average), although most recent USD primary market issuance has included Alternative Reference Rates Committee (ARRC) fallback language, which will make the process of switching to SOFR in the future less challenging.

    Delaying USD Libor cessation would allow more time for liquidity to develop in the SOFR-based derivatives market that remains a fraction of size of the interest rate derivatives market referencing Libor. This could support ARRC’s efforts to build a term reference rate by the middle of 2021, facilitating more primary market issuance referencing SOFR. ISDA has published a protocol to include fallbacks in legacy derivative contracts referencing Libor. A delay would give market participants additional time to make the necessary amendments (adoption is voluntary). It would also leave more time to enact possible state or federal legislation to reduce litigation and operational risks from legacy contracts.

    However, an extension would not automatically mean a smooth transition in mid-2023. We believe the slower shift to using SOFR as the benchmark rate for newly originated dollar cash products has reflected a ‘wait-and-see’ approach from some market participants, as well as SOFR’s lack of credit spread and term structure. Proactively embracing workable solutions would reduce, rather than simply delay, disruption.

    The ‘wait-and-see’ approach also reflects a less forceful approach by U.S. banking regulators relative to their UK counterparts, particularly in the transition’s early stages, although U.S. regulators have increased efforts to make sure risks are addressed. The Fed, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation said in response to IBA’s announcement that they ‘encourage’ banks to stop using Libor in new contracts as soon as possible and no later than end-2021.

    Contact:

    Andreas Wilgen
    Group Credit Officer, Structured Finance
    +44 20 3530 1171
    Fitch Ratings
    30 North Colonnade
    London E14 5GN

    Julie Solar
    Group Credit Officer – North America Financial Institutions
    +1 312 368-5472

    Monsur Hussain
    Senior Director, Financial Institutions Research
    +44 20 3530 1793

    Shampa Bhattacharya
    Director, U.S. Non-Bank Financial Institutions
    +1 212 908-9119

    Mark Brown
    Senior Director, Fitch Wire
    +44 20 3530 1588

    Media Relations: Sandro Scenga, New York, Tel: +1 212 908 0278, Email: sandro.scenga@thefitchgroup.com

    The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

    ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY’S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH’S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. DIRECTORS AND SHAREHOLDERS RELEVANT INTERESTS ARE AVAILABLE AT HTTPS://WWW.FITCHRATINGS.COM/SITE/REGULATORY. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

    Copyright © 2020 by Fitch Ratings, Inc., Fitch Ratings Ltd. and its subsidiaries. 33 Whitehall Street, NY, NY 10004. Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of Fitch’s factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third- party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of Fitch’s ratings and reports should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information Fitch relies on in connection with a rating or a report will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to Fitch and to the market in offering documents and other reports. In issuing its ratings and its reports, Fitch must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings and forecasts can be affected by future events or conditions that were not anticipated at the time a rating or forecast was issued or affirmed.
    The information in this report is provided “as is” without any representation or warranty of any kind, and Fitch does not represent or warrant that the report or any of its contents will meet any of the requirements of a recipient of the report. A Fitch rating is an opinion as to the creditworthiness of a security. This opinion and reports made by Fitch are based on established criteria and methodologies that Fitch is continuously evaluating and updating. Therefore, ratings and reports are the collective work product of Fitch and no individual, or group of individuals, is solely responsible for a rating or a report. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is not engaged in the offer or sale of any security. All Fitch reports have shared authorship. Individuals identified in a Fitch report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch. Fitch does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rate all or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000 to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than to print subscribers.
    For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. 337123) which authorizes it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001
    Fitch Ratings, Inc. is registered with the U.S. Securities and Exchange Commission as a Nationally Recognized Statistical Rating Organization (the “NRSRO”). While certain of the NRSRO’s credit rating subsidiaries are listed on Item 3 of Form NRSRO and as such are authorized to issue credit ratings on behalf of the NRSRO (see https://www.fitchratings.com/site/regulatory), other credit rating subsidiaries are not listed on Form NRSRO (the “non-NRSROs”) and therefore credit ratings issued by those subsidiaries are not issued on behalf of the NRSRO. However, non-NRSRO personnel may participate in determining credit ratings issued by or on behalf of the NRSRO.

    Originally Posted at Fitch Ratings on December 1, 2020 by Fitch Ratings.

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