The U.K. Financial Conduct Authority is urging CEOs of money management firms to stop buying LIBOR-linked cash products — including bonds and loans — by the end of the third quarter, but managers said that won't be an easy thing to do.
Managers say they are facing challenges when it comes to switching their strategies' exposure to LIBOR replacement rates-linked securities, such as the secured overnight financing rate in the U.S., known as SOFR, and the sterling overnight index average in the U.K., known as SONIA.
And even a coronavirus disruption is not going to give them breathing room when it comes to a transition away from LIBOR.
The U.K. financial services watchdog said on March 25 the effects of the virus on markets are not going to delay the expected timelines for when managers and banks operating in the U.K. should switch to buying and issuing products based on the new rates.
Debt managers in particular are currently finding it difficult to source SONIA-linked loans as banks are slow to issue them. Managers can't buy many products based on alternative rates today, said Adam Schneider, partner at Oliver Wyman Group in New York. Mr. Schneider added that a third-quarter 2020 move to alternative rates will be a problem because futures trading based on the new rates such as SONIA or SOFR still has low volume.
But LIBOR — which serves as a benchmark in many institutional portfolios for determining performance and features in structured products, real estate funds, corporate bonds and syndicated loans or leveraged loan funds — isn't being replaced by SONIA or SOFR effectively, other sources said.
When managers are left to buy only SONIA- and SOFR-linked securities at the end of the third quarter 2020, they expect to see an impact of the new overnight rates on the valuation, pricing and product costs. That's because LIBOR is calculated as a six-month average interest rate and is not as volatile or spot-like as the overnight rates SONIA or SOFR. Investors and managers face a potential mismatch between the valuation, pricing and costs on LIBOR when moving to SOFR/SONIA products because of the differences.
Switches could also be charged to money managers' or their clients' bill, according to Richard Keers, London-base group chief financial officer at Schroders PLC, who warned on Feb. 12 that a conversion to replacement rates-linked products from LIBOR-linked products will result in a payment to account for the change in the underlying rate. "While new industry conventions are being developed to minimize the value transfer (that would have to be paid at the time of the transition), they will not remove it entirely," he said on Schroders' website. "This payment could be due to or required to be paid by a client's portfolio."