In the run-up to the transition from Libor to an alternative reference rate at the beginning of July this year, the Depository Trust & Clearing Corporation’s (DTCC’s) Ann Marie Bria looks at the various permutations impacting market participants and the role DTCC is playing in helping firms navigate what is likely to be a challenging period.
Libor—the basic rate of interest used to determine lending rates between banks and reference rate interest calculations on various instruments, including adjustable-rate mortgages, asset-backed securities, municipal bonds and credit default swaps—will shortly be discontinued in the US. Other markets, including those in the European Union and the UK, have already converted to the euro short-term rate (€STR) and sterling overnight index average (Sonia), respectively, while the US will transition to the secured overnight financing rate (SOFR) at the beginning of July. Naturally, this move is likely to impact a variety of market participants from both an operational and technological perspective.
Ann Marie Bria, managing director and general manager, asset services, at DTCC, says the upcoming Libor cessation move in the US is a sizeable and complex undertaking, especially considering the number of legacy securities still using Libor to calculate their interest rate payments and, consequently, their value. “Obviously it’s an unprecedented event,” she explains, referencing the fact that the industry has yet to witness the total discontinuation of a benchmark index in its history. “When considering our clients, the impact of this cessation on securities management and everything that goes along with it, Libor has been the benchmark index for the majority of debt issuance for more than 35 years, with a massive number of securities that are indexed against it, which, come July 1, will need a new benchmark.”
A huge challenge
Bria explains that the cessation of Libor presents the market with what she describes as a “huge challenge” in understanding what these legacy contracts will fall back to, which will impact an estimated hundreds of thousands of securities. “Some of these securities may have fallback language within their documentation, but some don’t,” she says. “If they do speak to an alternative reference rate, it is likely the language would include optionality. As a result, investors may not have a clear understanding of what that security is going to be come July 1. The market challenge is understanding what each legacy Libor’s new benchmark will be and getting that information out into the market so that systems can be updated appropriately and in a timely manner.”
The importance of this information being disseminated is to ensure current and new contract holders understand what the index legacy contracts will be based on, to anticipate not only the interest payments yielded by those securities but also the price they would be willing to pay and how they would value them and their portfolios.
The way forward
The Federal Reserve Board and the Federal Reserve Bank of New York established the Alternative Reference Rates Committee (ARRC) to assist the industry in the transition from Libor and, in mid-March this year, DTCC announced it had launched its Libor Benchmark Replacement Index solution with support from the ARRC. The service enhances DTCC’s Legal Notice System—or LENS—platform, a mature offering initially unveiled around 20 years ago, designed to provide issuers and agents with a means of accessing the investor community.
“The idea was to create a central portal for issuers, agents and determining persons—the legal term for those responsible for determining the new fallback indexes—to come in and disseminate this standardized information into the marketplace,” Bria says. “We also have a recommendation from the ARRC from a best practice perspective: they are endorsing the tool and recommending the market use it. Whether you are the issuer agent, who has a need to disseminate the data, or a data subscriber who needs to update reference data, you can come to the centralized portal where you can access all of this information on these securities, and it is standardized.”
A manual alternative
US-based financial services firms impacted by the cessation of Libor are under no obligation to subscribe to the LENS service, although the alternative of having to manually reach out to agents about new index rates is understandably unappealing, even for fund managers with the resources to do so. “For firms that do not leverage this solution, it is likely to be a very manual and non-standardized process,” Bria says. She adds that the main objective of the ARRC’s Operations and Infrastructure Working Group is to ensure an operationally accurate and efficient process to get new benchmark indexes on legacy securities from issuers, agents and/or determining persons into the market. Partnering with them to create a centralized, streamlined and standardized tool provided a great opportunity for DTCC to use its connections within the industry to help provide a solution for an unprecedented event.
As for what makes the LENS offering so appealing to the market, there are several problems it addresses, among which is the availability of centralized and standardized data, which Bria explains are the two key components to all the issues around reference data and corporate actions information. “You’re going to get the same data elements and they’re going to mean the same thing, irrespective of who the agent and issuer are,” she says. “You have that confidence because of the standardization, and you are getting it all in one place. From an agent issuer perspective, you are leveraging the best practice recommendation established by the ARRC. That will help firms navigate the complexities of this significant undertaking.”
This article was originally published to WatersTechnology on June 05, 2023