Capital markets firms are at a critical point of the LIBOR transition. Switching to risk free rates from LIBOR has many hazards, such as adjusting to the compounded method of calculating interest rates, onboarding systems that can handle that model, and getting the right pricing sources to capture market data.
Passive transitioning of existing positions gives asset managers less control over their portfolios than an active transition, says Bhas Nalabothula, head of institutional rates at Tradeweb, as the active model allow portfolio managers to better reflect existing risk in a new set of positions.
With so much change occurring around rate policy and year end it is easy for firms to fall behind on the process, Nalabothula notes, and gives examples of how some firms are making the best of the process.
Dan Barnes: Welcome to Trader TV – your insight into trading for professional investors. I’m Dan Barnes.
The transition from LIBOR as a benchmark to new risk free rates is well underway. In some markets is completed, in others it has not. Joining me today is Bhas Nalabothula, Head of Institutional Rates at Tradeweb, and we’re going to be discussing how institutional investors can engage in best practice to make the transition smooth.
Bhas, welcome to the show.
Bhas Nalabothula: Thanks, Dan. Great to be here.
Dan Barnes: So firstly, tell us how urgent is preparation for the LIBOR transition and in which markets?
Bhas Nalabothula: We are at a critical point of the transition. Just to set the table of where we are across the different currencies. In Swiss and Yen, we’re effectively complete. We’ve seen the clearing houses convert the existing Swiss and Yen LIBOR positions into their new risk free rates. So far, the feedback on that has been very positive. We have the Sterling LIBOR transition at the CCP’s on the weekend of December 18th, and the major market, the largest of all, dollar LIBOR market, will be transitioning into a world of no new LIBOR risk by the end of this year.
This has obviously been a year where a lot of investment has been focused on the LIBOR transition. Market participants have had to do a lot of technology, work, systems work. Primarily we’re talking about the interest rates swaps market, but at the end of the day, loans are included, mortgages are included. LIBOR is being used in trillions and trillions of instruments across the globe. And that’s what makes this switch so complex.
Dan Barnes: Got it! So what are the hazards then in making the switch?
Bhas Nalabothula: The hazards are around just ensuring that systems are ready for it, ensuring that they can handle the payments, which are slightly different because with the new risk free rates, they’re compounded as opposed to having a payment that’s just set at the beginning. So ensuring that your systems can handle that, ensuring that you have the pricing sources to capture market data for these new risk free rates, these are all things that clients have had to get ready to prepare for the switch.
Dan Barnes: Very good and are there best practices in moving positions to get the best outcomes for investors and clients?
Bhas Nalabothula: There’s really two ways to approach kind of the transition from a LIBOR index to a risk free rate. Passive and active. So the passive transition that we just saw recently with Swiss and Yen is, you can allow the clearing house to convert your position. You can rely it to fall back to convert your existing position from one index to the other. That has some benefits in the sense that you don’t have to actually change anything, but you need to ensure that your systems can handle the newly booked trades.
Whereas what we’ve recommended is the active transition. So with an active transition, the client actually decides which trades in their legacy book they want to move into the new indices. In some instances, average position one to one. In some cases, they’ll take a set of positions and convert that into a new set of smaller positions that reflect the same risk against the new index. So the clients get full control over how those new positions are structured. And we’ve seen clients use the Tradeweb List Trading tool to actively transition those positions. So that’s something that we’ve worked very closely with our clients on.
Dan Barnes: And then what has been causing people to drag their feet?
Bhas Nalabothula: In terms of priorities we’ve got a new COVID variant, we’ve got inflation, we’ve got central bank policy figuring out where that’s headed. That’s obviously going to take a lot of focus from investors. But what we see generally in these types of transitions that are regulatory driven or kind of market structure changes, is that clients tend to get things done at the last moment.
They wait on things like liquidity to improve. A lot of the initiatives that regulators have done across the globe have helped that liquidity improve. So in the UK, we have the SOFR First Initiative, in the US market we’ve had the SOFR First Initiative. Now that those kind of hurdles are out of the way, I think it’s just getting down to doing that transition.
Dan Barnes: Then finally, is there a call to action for those firms that are still engaging in the process?
Bhas Nalabothula: It’s critical to note for the dollar market, you know, the end game is here. We have to transition these existing LIBOR contracts into SOFR or other rates in a very short period of time. So we encourage clients who haven’t made the transition to contact us and use the functionality that we’ve built out, because come into the New Year, there won’t be any new LIBOR risk. US regulators have made that very clear, and US dollar LIBOR will be the only market still trading, so we want to ensure that clients are correct for us.
Dan Barnes: Bhas, thank you so much for your time.
Bhas Nalabothula: Thanks Dan. Really appreciate being here.
Dan Barnes: I would like to thank Bhas for his insights today, and of course, you you’re watching. To catch up on our other shows or to subscribe to our newsletter, go to TRADERTV.NET.