Following the SEC’s statement on LIBOR transition, some investment advisers are offering up disclosures on the topic. But are mere disclosures sufficient? To find out, RFG invited Adam Schneider and Serge Gwynne, partners at Oliver Wyman, to advise members of the RFG consortium on issues faced by GPs. Schneider and Gwynne commented on three major risks that should be addressed, plus a significant opportunity.
By way of background, LIBOR is almost ubiquitous, with notional amounts of LIBOR-based loans totaling about $240 trillion, and has been called “The World’s Most Important Number.” But this will soon end: in 2017 Andrew Bailey, CEO of the UK Financial Conduct Authority, announced it would stop supporting LIBOR after 2021, and LIBOR is likely to end at that time. Asset managers will have to manage through this sea change in the financial markets, and the resulting impact on portfolios. Merely disclosing how LIBOR will transition through market conventions into new replacement rates is not enough, as this misses the fundamental business issues that need to be addressed.
Schneider and Gwynne noted that navigating the transition will require three large-scale programs to be executed:
Understanding the upcoming replacement products.
Managing existing LIBOR exposures.
Managing customers/stakeholders who need to understand both changes to existing portfolios and impacts on their investment choices.
Schneider and Gwynne also commented on three major risks that should be addressed, and identified a significant opportunity.
Get ready for fallbacks—but also get ready to negotiate since there almost certainly will be value transfer between parties, and this will be contentious.
Watch out for inconsistency in fallback triggers.
Undertake a quantitative analysis to assess the economic impact of the market moving to a risk-free rate (with different risk characteristics than LIBOR-based products).
The major opportunity is re-thinking pricing propositions, which up until now have been simplified through the near ubiquitous use of LIBOR.
LIBOR transition is coming. If the current regulatory intent holds, it will occur early in 2022. Even if that is optimistic, it will likely only extend by 1-2 years. Schneider and Gwynne say time is of the essence if products based on the new rates are to be understood and the back book is to be transitioned. There is little time and much to do, and mere disclosures will not be sufficient to traverse the transition from LIBOR to ARR-based products.
Detailed information on the above points was shared with RFG consortium members in a recent newsletter. For more information about RFG’s services, write to Information@RegFG.com.