LIBOR TransitionMarket Update: February 16 - 29 2020

1 - HighlightsBoE announces LIBOR collateral haircutsFCA issues Dear CEO letter to AMsEBRD’s unconventional SONIA issuanceISDA’s pre-cessation consultationEuro WG report on moving liquidity to €STRFCA’s Edwin Schooling-Latter speech

2 - RFR Derivatives TradingSwapsFutures

3 - RFR Adoption:Cash ProductsFRN IssuancesOther Cash Products

4 - ISDA/AMG Benchmark Strategies Forum

5 - Publications at a GlanceARR Working GroupsRegulatorsIndustry Groups

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670 days to Dec 31, 2021

HighlightsBoE announces haircuts for collateral referencing LIBOR

What happened? The Bank of England announced it would apply progressively increasing haircut add-ons to existing LIBOR linked collateral, with haircuts reaching 100% by year end 2021. In addition, the majority of LIBOR linked loans and securities will be ineligible for use as new collateral after October 1 of this year.

Our Take: The announcement came in a week that saw additional activity that continues to build the momentum in the transition from LIBOR, including regulator remarks at the ISDA/ AMG forum, ISDA’s pre-cessation fallback consultation and the FCA’s Dear CEO letter to AMs. There was also the BoE’s announcement of its planned publication of a SONIA index, which will likely be welcomed by lenders and issuers alike. Regulators and industry bodies are setting the pace - and firms will need to keep up.

The haircuts are another step to incentivize SONIA issuances in advance of the ambitious Q3 target for an end to GBP LIBOR issuances. Firms that currently secure funding with the BoE need to map to which extent they rely on LIBOR-linked collateral - and will need to make plans to stop relying on such assets. As existing LIBOR assets will have decreasing value as collateral for BoE funding, liquidity and pricing will likely be impacted as well.

The extent to which regulators will further open up the regulatory toolbox in 2020 to either incentivize new RFR issuances or penalize LIBOR issuances remains to be seen - but further action appears likely should transition efforts not accelerate.

PwC | LIBOR Transition

FCA’s stern “Dear CEO” letter to asset managers

What Happened? The FCA sent a “Dear CEO” letter to all asset managers regulated in the UK, including investment firms and managers of AIFs. The FCA articulates expectations for the transition from LIBOR to ARRs, cautioning firms to not expect, await or rely on future regulatory relief, guidance or legislative solutions. Directly addressing firms that may not yet have initiated a program, the FCA calls for immediate action to develop and execute on a transition plan.

The FCA reiterates targets and milestones previously communicated by the WG on Sterling RFRs (and endorsed by the BoE), providing examples as to how they apply to AMs. For example, in light of the WG’s stated target of ceasing issuance of GBP LIBOR- based cash products by the end of Q3 2020, AMs should consider not making investments in such products on behalf of their clients at that time as well. The letter also outlines considerations for products and services with LIBOR exposure, the development and offering of new products based on ARRs, investing on clients’ behalf and managing conflicts of interests. The clear governance expectation is that the Board oversees the transition, including ensuring that the transition plan holistically considers all businesses and products and is resourced adequately. The FCA closes by reiterating that transition activities should already be underway at firms. Rather than requiring a response, firms are asked to notify the regulator of any insurmountable barriers or delays in transition.

Our Take: The scope of the letter includes numerous UK regulated entities of foreign-based AMs, and while its specific milestones are focused on the transition from GBP LIBOR, firms in all geographies should view the letter as an opportunity to re-evaluate their global transition plan holistically. In doing so, they will need to consider jurisdiction-specific timelines, especially in cases where the UK entity may rely on central program initiatives or resources as part of their preparations. The almost impatient tone of the letter underlines the regulator’s expectation for Boards to assume accountability and show urgency in mobilizing a transition plan and supporting resources, especially if the group is slow to get a program off the ground.

The risks, considerations and expectations articulated in the letter are just as relevant and applicable for the transition in other currencies, and so is the urgency with which firms should prepare now. In addition to the ARRC’s recently published checklist, buy-side firms

should view the FCA’s letter as another resource to assess their programs and enhance and accelerate them where necessary1.

EBRD’s unconventional SONIA issuanceWhat Happened? The European Bank for Reconstruction and Development (EBRD) issued a £750 million 3-year SONIA FRN. Interestingly, the chosen method for calculating interest differs from that used in other recent SONIA-based FRN issuances, for which issuers have consistently employed a five-day lag, or “lookback.” Here, the EBRD opted for the “observation period shift,” which differs in how holidays and weekends are treated over the interest rate period. Although the lookback approach has emerged as the standard for GBP FRN issuances, the observation period shift is favored by the Alternative Reference Rates Committee (ARRC) and has thus been most prevalent in USD FRN issuances tied to SOFR. It is also the approach used by the FRB NY in their SOFR index calculation and is expected to become the standard in derivatives markets’ transition to overnight rates.Our Take: While the economic impacts resulting from this difference in calculation methods are minimal, the EBRD clearly saw value in aligning its approach to that used in other currencies and other products. Its choice shows us that institutions are continuing to evaluate what conventions “should” be for new instruments. Firms that are actively involved in developing these products should take the opportunity to engage in industry discourse and shape evolving convention as much as possible rather than waiting for standards to be dictated to them. At the very least, they will need to understand the implications of different approaches in the context of their business environment, especially as even conventions that were seemingly converging toward a standard might still change.

ISDA’s pre-cessation consultationWhat Happened? ISDA released its latest - and likely final - consultation on the inclusion of pre-cessation fallbacks for derivatives tied to LIBOR, essentially in the form of a Yes or No question. ISDA is asking firms whether pre-cessation triggers should be included alongside permanent cessation triggers as part of its upcoming protocol, noting that it would do so if 65% of respondents support this proposal. If that threshold were not met, ISDA would provide an opt-in provision for pre-cessation triggers as part of the protocol. ISDA will hold a March 4 webinar on the consultation.

Market Update: February 16 - 29 2020

21For more information: PwC At a Glance: FCA calls on AMs to act & Financial Times coverage

PwC | LIBOR Transition

Our Take: Circle “Yes” or “No.” While ISDA is likely to meet its minimum threshold for number of respondents (70, with a minimum of 35% of non-banks or infrastructure providers), it remains to be seen whether ISDA’s correspondence with the FCA, ICE, and LCH has provided sufficient clarity for market participants to come to a consensus on this issue. Pre-cessation trigger optionality would allow for a scenario in which triggered and untriggered contracts might trade at the same time. That may result not only in pricing mismatches, risk management complications, but also a bifurcation between cleared and bilateral swap markets - as LCH’s latest rule change proposal includes hardwired pre-cessation triggers for cleared LIBOR swaps.

Euro WG report on moving liquidity to €STR

What Happened? The WG on euro RFRs issued a report on the transfer of EONIA’s cash and derivatives markets liquidity to €STR. For derivatives, It recommends that market participants replace EONIA with €STR in anticipation of the June 22 discounting switch target and begin pricing products €STR by

default. For cash markets, market participants are encouraged to, communicate between each other and with their customers on long duration legacy contracts, reduce EONIA linked legacy exposure as soon as possible, screen and test systems to ensure they can manage products referencing €STR, and follow closely the specifications of the current EONIA products for €STR products in order to facilitate the development of market consensus.Our Take: The date for the CCP discounting switch from EONIA to €STR is approaching fast. Firms should actively be preparing now, including the testing of systems functionality. We expect more industry discussion around the value change in swaptions that expire after the discounting switch. Without offsetting compensation, the difference in discounting curves as defined in CSAs and €STR might result in unintended P/L impacts for accounting purposes. An additional complexity is that these swaptions are bilateral contracts, negotiated with multiple parties, which makes the transition of CSAs an onerous task.

Similar to the ARRC, the WG on euro RFRs is expected to consult on the issue shortly,

Market Update: February 16 - 29 2020

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FCA’s Schooling-Latter speech

What Happened? The FCA’s Edwin Schooling Latter spoke at the ISDA/AMG Benchmark Strategies Forum. While a transcript isn’t available, ISDA covered the speech on social media (source: www.twitter.com/isda). For more of ISDA’s coverage of the forum see section 5.

PwC | LIBOR Transition

2 RFR Adoption: DerivativesSwaps Trading

Market Update: February 16 - 29 2020

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Source: swapsinfo.org

€STR: Notionals and trade counts remain minimal.

Our Take

SONIA liquidity was a topic at the ISDA/AMG forum, with the FCA’s Schooling-Latter noting that SONIA swaps volumes doubled in January vs. the average over previous months. The BoE’s Andrew Hauser added that half of cleared sterling swaps in ‘19 referenced SONIA.

In the last week of trading before the PRA / FCA March 2 target to switch the convention for Sterling IR swaps to SONIA, notionals traded for SONIA swaps approached the peak levels seen at the end of January. In the week ending Feb 28, $3.85bn SONIA-linked notional was traded for every $1bn notional traded in GBP LIBOR swaps - a significantly higher share than in past weeks, and even higher than what was seen at the end of January during the first peak in SONIA swap trading

Notionals traded in other RFR-linked swaps remain considerably lower, though notionals in SOFR-linked swaps almost doubled last week compared to the week ending February 21 - but the market remains heavily dominated by LIBOR.

Risk.net reported that the first SOFR-linked swaptions traded in early February. Goldman Sachs executed one-year and two-year options on ten-year swaps. A JPM spokesperson confirmed that the bank had also executed recent swaption trades with clients.

Risk.net also reported that JPM and the National Bank of Canada had executed the likely first SOFR-CORRA basis swap in January. The two-year CAD 5m swap used daily compounding for both legs of the trade.

PwC | LIBOR Transition

Futures

Market Update: February 16 - 29 2020

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Our TakeLast week saw increased trading in ICE and LCH SONIA futures. Trading volumes for LCH 3M SONIA Futures have been near those seen for 3M LIBOR over the past few weeks. CME SONIA Futures have not been able to reach February the peaks in trading volumes achieved in January.

February has seen increased volumes for both 1M and 3M CME SOFR futures, with trading reaching its second highest daily volume since launch with 110k contracts on February 20. However, volumes remain considerably lower than those seen for 30-day Fed Funds and 3M Eurodollar Futures, respectively. We are also not seeing a reduction in the share of 3M Eurodollar futures maturing beyond December 21, which has hovered around 27-30% of total 3M Eurodollar futures since the beginning of the year (in volume terms).

The week ending Feb 14 saw the first 3M SARON Futures contracts traded on Eurex this year.

Source: CME, ICE Source: CME, LCH, ICE

PwC | LIBOR Transition 6

Other Cash Products

RFR Issuer Detail ResourcesSONIA UKMBA

(UK Municipal Bonds Agency)

Launched its first bond, a £350m five-year FRN tied to SONIA - ending a six year wait after finalizing the syndicate and mandating HSBC as global coordinator.

Room151

EBRD Issued a SONIA-linked FRN using “observation period shift” as opposed to the “lookback” approach to coupon calculation

Pricing Supplement

SOFR CPP Investments (Canada Pension Plan Investment Board)

Reported in its Q3 results for fiscal 2020 that its subsidiary, CPPIB Capital, had issued a $500m Green SOFR-linked FRN, its third green bond

CPP Investments Press Release

Fulton Financial Announced pricing of a $200m fixed-to-floating note due 2030 and a $175m fixed-to-floating note due 2035 which expect to use Three-Month Term SOFR

Fulton Financial Press Release

Freddie Mac Preparing to issue a $870 m SOFR-linked K-Cert with a guarantee that covers any floating interest rate basis risk if the value of SOFR exceeds the value of LIBOR

yahoo!finance

EIB (European Investment Bank)

Launched the first SOFR-linked FRN tied to the Fed’s SOFR index, employing a ‘shift’ coupon calculation rather than the ‘lag’ methodology it had used previously

GlobalCapital

Market Update: February 16 - 29 2020

RFR Adoption - Cash ProductsFRN Issuances

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SOFR Issuances (in bn)• 83 institutions have issued $400+ billion notional in

FRNs tied to SOFR, including nearly $50 billion in February 2020 - the second highest monthly total since SOFR’s introduction.

SONIA Issuances (in bn)• There have been over 100 SONIA bond issuances

totalling close to £80bn since 2018. Similar to the prior January, there was a large increase in issuances in January 2020 - with nearly £10bn in new issuances.

Source: Bloomberg

PwC | LIBOR Transition 7

4 ISDA/SIFMA AMG Benchmark Strategies ForumBelow is a selection of quotes and commentary* from the February 26 ISDA/SIFMA AMG Benchmarks Strategies Forum in London. The event also featured opening remarks by ISDA CEO Scott O’Malia and keynote addresses by the Bank of England’s Executive Director, Markets, Andrew Hauser, and the FCA’s Edwin Schooling-Latter.

Market Update: February 16 - 29 2020

*Source: twitter.com/ISDA

Transition of legacy non-cleared derivativesLiquidity in RFRs

How market participants are adaptingWhat firms need to do now

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Publications at a Glance (in chronological order)Alternative Reference Rate Working Groups • The WG on euro RFRs published a report on the transfer of EONIA’s cash and derivatives markets to €STR• The Cross-Industry Committee on JPY IR Benchmarks published minutes of its January 31 meeting, as

well as an agenda and meeting materials for its February 25 meeting. Meeting materials included an update on and plan for development of term rates. Following the meeting, the committee announced the vendor selection of Quick Corp. for the calculation and publication of prototype term reference rates

Regulators• FCA: Issued a sternly worded Dear CEO letter on LIBOR transition to asset management firms, urging them

to prepare now for the end of LIBOR• BCIS: Begun the publication of a newsletter on benchmark rate reforms, clarifying the treatment of capital

instruments amended for the purposes of benchmark rate reforms• U.S.: Chief executives from 10 mid-sized U.S. banks wrote to regulators voicing their support for Ameribor as

an additional alternative to USD LIBOR• Bank of England: Published a discussion paper seeking input on the publication of a SONIA index and

backward looking SONIA averages. Responses (via web survey) are due April 9. Andrew Hauser spoke at the ISDA/AMG forum on turbo-charging the LIBOR transition and the role of the BoE. He also referenced BoE’s planned haircuts on LIBOR-linked collateral, announced a day earlier.

• China: The Taipei Times reported that the Bankers Association of the Republic of China would publish a first proposal next month on how Chinese banks should deal with LIBOR cessation

• FSB: In a letter to the G20 Finance Ministers and Central Bank Governors, the FSB is highlighting LIBOR transition as a key topic, noting it would release a report on outstanding issues prior to the group’s meetings in July, as well as an updated progress report on benchmark reform prior to the G20 meetings in November.

• U.S. House Committee on FS: Has scheduled a hearing on The End of LIBOR for March 25• SFA:Reported that a briefing on LIBOR transition was held for congressional staff on capitol hill• Association of Banks in Singapore: Held a series of webinars on the transition from SOR to SORA (replay

expected to be made available)• Bank of Canada: Announced it would begin publication of CORRA in June. It also published the

methodology describing the implementation of enhancements (e.g. basing the rate on a wider set of transaction data). The BoC’s pushing of CORRA as a potential replacement for CDOR (the Canadian Dollar Offered Rate, which is used more widely in swap markets) is akin to the promotion of SOFR as the USD LIBOR alternative; however, it is not entirely clear what the endgame for CDOR will look like.

• Bank of Japan: Deputy Governor Amamiya Masayoshi spoke on IR Benchmark Reform in Japan, again stressing the need for firms to accelerate their efforts. The BoJ also published his presentation slides

Industry Groups

• ICMA: A quick guide to the transition to risk-free rates in the international bond market defies its name in providing an in-depth state of play across all currencies

• ISDA: Published the (unsurprising) results of its supplemental consultation on Euro LIBOR and EURIBOR. ISDA also launched the awaited consultation on pre-cessation triggers

• LMA: Published a follow-up to its draft facility agreements referencing SONIA and SOFR, asking market participants’ inputs on outstanding issues prior to finalization (incl. computation conventions, how to reference the rates in the documentation, etc.)

5Market Update: February 16 - 29 2020