(With LIBOR for new contracts ending Dec. 31, 2021, and LIBOR’s usage finally over as of June 30, 2023, a new era for risk-free reference rates is underway. Financial services firms are transitioning to replacements such as the Secured Overnight Financing Rate (SOFR), and they are grappling with the post-LIBOR impacts upon their trading, risk, and collateral management operations. Firms will see that they need a strategic rather than piecemeal approach for the transition, says Sophie Foy, the global head of product marketing at Adenza. The company was formed by the merger of Calypso Technology, which last year won the FTF Award for Best Buy-Side Collateral Management Solution, and AxiomSL. FTF News recently got time with Foy for the Q&A that follows.)
Q: So, the LIBOR transition will impact hedging, risk, and related data management activities. What has been the biggest impact upon the collateral, funding and clearing operations of most firms?
A: Indeed LIBOR reform has been one of the largest structural changes in the financial world.
While its impacts on the front office have often been better understood than others, the LIBOR transition is cross-functional with implications for many functions: risk, treasury, clearing, margin and collateral management, back-office, and accounting.
Some of most impactful requirements — all of which must be executed with complete consistency — include:
- Support of new funding rates
- New collateralized pricing
- Conversion of legacy LIBOR portfolios
- One-off conversion fees management
- Novation for cleared and uncleared trades
In addition, because the market is still evolving toward a risk-free rate (RFR) landscape across products, clearing channels, client segments and currencies, firms continue to face a major challenge. This state of change heavily impacts the risk management and valuation of hybrid portfolios, collateral funding rates, and market data.
Q: What has been the biggest impact upon back-office operations of the LIBOR transition?
A: The conversion of legacy trades, cleared and uncleared, has been one of the biggest challenges from a post-processing perspective. We initially identified requirements for a bulk novation tool including support for RFR new parameters and new conventions like the business-day lookback.
But beyond the tool itself, it became critical to offer our clients holistic support for all use cases, spanning systematically converted cleared trades, client trades processed on an ad-hoc basis, and bilaterally negotiated spreads or fees. The resulting requirement for an evolving novation tool and quickly changing market best practices had a tremendous impact on back-office operations.
Q: There have been surveys and news reports showing that some securities firms are behind in their transitions. What would you say to a firm working in derivatives markets that is resisting the transition away from LIBOR?
A: Navigating an ever-changing regulatory landscape has become a huge undertaking for financial institutions in recent years. Complying with the wave of new regulations is challenging in itself.
Instead of tackling these changes piecemeal, firms that proactively adopt a strategic view and develop a comprehensive, unified approach to the challenge will achieve long-term benefits that extend far beyond compliance.
In the context of the LIBOR transition, firms can certainly still pivot to a strategic approach and reap those benefits. While some deadlines have already passed, key remaining LIBOR milestones lie ahead. Today, the market is still adjusting to RFR benchmarks and moving away from legacy trades, synthetic curves, and other workarounds.
Q: What advice do you have for firms that need to set priorities in order to catch up to the LIBOR transition deadline? What should those priorities be?
A: Financial institutions should start with the upcoming compliance deadlines including the 2023 US LIBOR deadline. But they should also prioritize the replacement of workarounds implemented for past deadlines, which might not scale or be effective as RFR liquidity expands and the last US fallback event takes place. Firms can use some simple questions to diagnose the need for a change:
- Will the current solution meet business performance SLAs?
- How will users move away from synthetic curves?
- Can the current solution accommodate new term rates and unexpected changes?
- How many manual new steps have been implemented during the benchmark transition process?
- Is the current solution adapted for linear and non-linear products?
Q: For 2022, what is the best strategy for firms that will have to manage a mix of offerings – some of which rely on LIBOR and others that are using a different reference rate? How difficult will this challenge be for them?
A: As the LIBOR market phases out in some jurisdictions and others establish an RFR environment, financial institutions must juggle old and new rates and parameters.
In addition to the immediate adjustment required to price trades and adjust risk metrics calculations, there are more challenges to come. The forward-looking term structures for RFR are nascent and migration best-practices are being defined. In this context, applying a front-to-back system rationalization enables firms to avoid multiple changes in disparate systems.
Even through the fallback event has fully taken place in Europe and partially so in the US, it is clear that 2022 will be one of the most challenging years of the LIBOR transition. Rules and regulations around rate benchmarks vary by currency and country. Thus, firms will need to manage pricing, valuation, and post-processing for portfolios mixing legacy LIBOR, synthetic curves, and RFR-based products and market data.
However, with a holistic and integrated solution that offers a systematic mapping of products and market data, clients can successfully navigate the transition’s current challenges. Unexpected use cases will arise, but with the foundation of a flexible platform, firms can achieve a seamless transformation to the new RFR landscape.
Q: The major CCP providers across the globe have been facilitating the move away from LIBOR. How should firms navigate the changes that the CCPs are making for a post-LIBOR world?
A: CCPs have created a very structured path toward the adoption of RFR products and the conversion of legacy LIBOR portfolios.
Now that the benchmark switch is under way, clearinghouses are offering paths toward optimizations via compression, netting, and cross-margining. Of particular note, changing regulations now include new collateral costs and capital charges. These are driven by uncleared margin rules (UMR) and standardized approach to counterparty credit risk (SA-CCR) parameters. Opting for clearing channels might be firms’ next step to proactively manage this regulatory framework.
Q: Are some of your customers using the LIBOR transition to uproot legacy hardware and software systems that are impeding an enterprise-wide response to LIBOR? If so, what new technologies are they embracing?
A: Yes, the LIBOR transition remains a key driver for firms to decommission legacy and fragmented systems.
For many of our clients, it has also created the perfect opportunity to initiate a modernization journey with a cloud-based, front-to-back integrated platform. Such modernization enables clients to benefit from the latest capabilities in terms of application delivery and deployment. We have observed two main drivers for transformation:
Q: What are the new data management requirements that firms must consider as they shift toward a post-LIBOR reference rate?
A: The adoption of new benchmarks has increased the complexity of data management creating the need to support three sets of market data in parallel:
- New RFR daily compounded indices
- Legacy LIBOR rates being progressively rolled out
- New synthetic LIBOR curves.
In addition, in the context of risk management – historical VaR [Value at Risk] and stress scenarios – financial institutions had to manage hybrid and synthetic historical data series. We enable many of our clients to recreate a consistent series of data points across the transition years. Data management around the new risk-free benchmarks is another area where flexibility has been key for our risk users.
Q: What will the new post-LIBOR world look like? Will there be new lines of integration among trading, hedging, risk, and back-office operations?
A: The LIBOR transition has provided firms with an excellent opportunity to transform their IT ecosystems and consolidate their strategic [over-the-counter] OTC trading platforms – front-to-back.
Taking an agile approach to software updates has proven instrumental to RFR adoption.
With so many moving pieces and quickly evolving requirements, our clients have been able to proactively convert their legacy portfolios, anticipating various fallback pricing milestones from a front-to-back to risk approach.
More importantly, they are prepared to efficiently handle the stream of forthcoming regulatory and market changes including:
- US LIBOR fallback (June 2023)
- Basel III/IV framework evolution
- UMR [Uncleared Margin Rules]
- Emerging ESG data and disclosure rules
These changes and others inevitably looming will require firms to establish strong integration among their trading, hedging, risk, and back-office operations — functions often more siloed than is optimal.
We believe that by adopting a strategic, holistic approach such as offered by Adenza (Calypso and AxiomSL combined) will be well positioned to adapt flexibly to life in the post-LIBOR world.