It really is a Smor Gås Bord…The decision on which post-LIBOR benchmark to use
In this blog we explore the increasing degrees of product-freedom available across post-LIBOR financial markets and the corporate finance suite. With the dizzying array of options seemingly available, we pose important questions for market participants to consider.
It’s not quite A Table Alphabeticall, and, somewhat amazingly, the Cambridge dictionary has only been available on-line since 1998, but they helpfully define the original Swedish noun ‘Smorgasbord’ as: a mixture of many different hot and cold dishes that are arranged so that you can serve yourself.
Why on earth is this relevant in 2021 finance? Well, we’ve come to the conclusion that the Swede’s mix of smor (butter), gås (goose), and bord (table) is the near-perfect metaphor for the world of post-LIBOR finance.
We field a lot of finance questions from many different clients, and increasingly note that there is a wide and increasing array of ways to contract new deals. All of these have quite different ‘gives versus gets,’ and component pieces. Some are refined, some are quite raw and participants appear to have to figure out how to serve themselves.
And it may be difficult for bankers to accurately describe what’s on all those platters.
It’s now over four years since Andrew Bailey gave his momentous ‘The future of LIBOR’ speech. Despite the opportunity that many of us expected that LIBOR reform would bend market conventions toward conformity, the lived reform experience has been of the market response leading us to a world of far greater complexity.
Corporate finance and financial markets products are not going to click together with the simple LEGO-like efficiency of LIBOR products: new benchmarks are really quite different. Not just a little different; a lot different (think volatility).
So, what kind of basic questions should one consider when approaching the post-LIBOR deal ‘bord’?
Do I really understand the underlying nature of the Alternative Reference Rate (ARR) I’m about to reference and use in contracts?
How have ARR’s, or proxies, performed in terms of realised outcomes, annual ranges and historical volatility?
What do ARR’s actually do at times of market disruption and heightened market volatility?
Am I willing to accept the credit sensitivity of the financial sector remaining at play in my all-in cost outcome? The credit sensitivity is a feature of LIBOR and ARRs such as BSBY, Ameribor, CRITR and AXI.
Could there be an all-in-rate advantage to accepting credit sensitivity?
s the choice of ARR different for a borrower or investors?
Then, excuse fingers, there are real questions about what type of cutlery is available to help consume all these trimmings?
Term RFR’s seem like a viable solution, but can I access them if regulators impose use-case limits?
If I go term rate (credit sensitive or RFR) and need a derivative hedge, am I sure I can get one?
If I get a hedge, will it work like traditional LIBOR hedges did in all cases?
Speaking of that hedge, what about in three- or five-years’ time if use-case limits change and liquidity dries up?
Cross currency swaps are two-day lagged, my cash instrument is five-day lookback, how am I (and my auditor) going to handle the exposure to basis risk and short-term liquidity?
Can I get a convention match?
We’re not sure what part of the smorgasbord metaphor we can use for the other important considerations, but perhaps these are best described as condiments?
My bankers insist on imposing an interest rate floor, isn’t that now at-the-money?
Shouldn’t that floor also be embedded in the hedge?
What’s this difference between period-floors and daily floors in the RFR facility, and why does it matter?
Bloomberg Index Services Limited rates show some large differences in credit-adjustment-spreads between currencies and tenors in the ISDA fallback conventions, but my bankers want a one-size fits all margin in my multi-currency facility. What the gives here?
To gain a better sense for the practical realities we spoke on this topic with Managing Associate, Yu Zhang, a specialist in the banking at corporate finance practice at leading legal firm, Allens Linklaters in Sydney.
“I think the smorgasbord analogy is quite apt.
The range of possible ARR/RFR conventions is somewhat daunting, then there’s the choice between credit-sensitive and essentially credit-risk free rates, and we think clients need to evaluate each of those areas very carefully. Then, for corporate finance and securities issuance, there are a range of risk-free-rate contractual facets that need to be considered, also carefully given the way these can influence economic outcomes.
Whereas a standard LIBOR corporate facility of old might contain three or four contractually meaningful elements (i.e., that can impact economic outcomes), when we deal with RFR-based deals, there are a lot more.
People should pick their meal from this smorgasbord carefully, and I think that view, that caution, is generally better understood than it was only a few months ago.”
Yu Zhang, Allens Linklaters
What’s dawning on market participants is this: if you attempt major global cross-jurisdictional reforms and invite market regulators, the sell-side and the buy-side, and the loan-markets and derivative markets industry bodies to the same dinner party, not everyone wants a Big Mac.
Which is a recipe for confusion.
For those charged with determining efficient capital costs or maximising returns we think it will be important to be able to cut through the confusion, and soon.
And lastly, try to avoid being the Gås!