| LCH circular number: | 4146 |
|---|---|
| Date: | March 18, 2021 |
| To: | All SwapClear Users |
LCH Group (“LCH”), and its SwapClear business, remains strongly supportive of industry-wide efforts to transition from existing benchmarks to risk-free rates (“RFRs”). Given recent announcements from their regulator[1] and from their administrator[2], representative LIBOR benchmarks which are published in 5 currencies and which remain in widespread use are confirmed as being discontinued from 31st December 2021 in all but US Dollars, the main tenors of which are being discontinued from 30th June 2023. This cessation of the publication of representative LIBORs necessitates the adoption of RFRs in their place.
On 16th February 2021, LCH issued a circular[3] to summarise the outcome of its consultation[4] regarding the treatment of its outstanding cleared LIBOR contracts at or around an Index Cessation Effective Date[5] (“ICED”) and their potential conversion into (or replacement with) corresponding RFR-based contracts.
In our circular, LCH reported a majority of feedback amongst our SwapClear service participants to proceed with a compensated conversion into standardised RFR contracts at or shortly before an ICED. We also reported that we proposed to carry the spread adjustment on the market-standard RFR leg of these RFR trades, based on majority feedback. This second circular aims to provide further key details to SwapClear participants on these and other elements of our planned approach.
The conversion processes in 2021 will encompass CHF / EUR / GBP / JPY LIBOR contracts. Further communication regarding USD LIBOR trades will be provided closer to the relevant ICED date.
As previously announced, LCH intends to charge fallback fees (from 30th June) and a conversion fee for those contracts which cannot otherwise be amended and so remain outstanding at the conversion event. In line with regulatory guidance[6], LCH strongly recommends that participants consider proactively transitioning away from fallen-back benchmarks, and these fees aim to encourage early transition before our conversion processes are run, to reflect the increased interim costs of risk management ahead of them, and to recover LCH’s costs in providing them as a backstop.
Ahead of the conversion events, LCH will provide tools and materials to ensure users are aware of alternative options available to minimise use of the conversion tools and associated fees. Further details as to final fee levels and LCH’s analytical support will be provided in our upcoming Rates Service Update and via a service-wide circular.
Supplementary Detail
Timing
Further to IBA’s recent confirmation of its timetable, to ISDA’s confirmation of the relevant Index Cessation Effective Dates[7] and based on feedback to conduct our conversion processes as close to these dates as possible, LCH proposes the following dates:
- For CHF, EUR & JPY LIBOR, conversion shall apply to SwapClear Contracts outstanding at COB on Friday 3rd December 2021 and will be conducted over that weekend;
- For GBP LIBOR, conversion shall apply to SwapClear Contracts outstanding at COB on Friday 17th December 2021 and will be conducted over that weekend.
Standardisation
In light of our user-backed decision to carry the spread adjustment on the RFR leg of the converted contract, LCH wish to confirm that we also intend to retain the roll dates & accrual periods of the original LIBOR contract, to use compounded RFRs as applicable over those periods and therefore to apply currency-specific payment lags to these legs in line with current market conventions for RFR-based swaps. LCH intend to leave all terms and conditions of the non-LIBOR leg unchanged, as per our participant’s original selections, without introducing any payment lag.
Treatment of Spread Adjustment
LCH wish to confirm that the spread adjustment on the RFR leg will be the relevant Spread Adjustment published by Bloomberg Index Services Limited and will be carried at its full degree of accuracy without any rounding.
Treatment of representative LIBOR fixings
Consultation respondents provided extensive feedback regarding their preference to maintain, without change, payments associated with periods on their original LIBOR contracts which could be fulfilled with reference to a representative LIBOR. Specifically, such representative LIBORs: (i) could on LCH’s conversion date have already been applied to the relevant period of the original LIBOR contract but have not yet been settled; or (ii) could be capable of being applied to a period which would otherwise make use of one between LCH’s conversion date and the date of last publication (of a representative LIBOR). In response, we intend to preserve this outcome where possible[8]. This treatment aims to maximise alignment with bilateral LIBOR-based contracts
Legal characterisation
In line with consultation feedback, LCH plan to characterise the conversion as an amendment of the SwapClear Contract, and we are exploring an election mechanism for participants who wish for characterisation as a termination of the original and its replacement with a new RFR-based SwapClear Contract. We confirmed our approach to operational treatment, being a termination of the original LIBOR contract and re-booking as an RFR contract, in our prior circular.
Treatment of Basis Swaps
After careful consideration of technological and operational factors, LCH have determined that we intend to split each Basis Swap contract that would on conversion otherwise result in an RFR/RFR contract into a pair of fixed / floating contracts in a Preparatory Conversion Event on a Preparatory Conversion Date in late Q3 2021. Further details and the date of this Preparatory Conversion Event will be provided shortly.
Treatment of FRAs
Further to our statements regarding the proposed treatment of FRAs in our circular[9] dated 19th January 2021, LCH intend to convert each FRA directly into a corresponding single period RFR swap contract as an integrated part of the conversion event in each currency.
Next Steps
The additional detail provided in this circular is intended to address the central open design questions associated with our conversion processes, and to communicate the schedule on which these events are proposed to take place.
As with any major delivery from SwapClear, we will now proceed to provide materials covering technical specifications and operational schedules as soon as they are available and as early as possible, through channels such as our fortnightly Rates Service Update and via LIBOR webinars. Equally, LCH will develop support tools and functionality such as enhanced reporting to assist members & clients in their preparations.
Any process will be subject to risk governance review and regulatory non-objection and is therefore subject to change.
Should you have any comments or questions on these outcomes, or if you require further information, please do not hesitate to contact LIBOR@lseg.com or LCHGlobalSRM@lch.com.
[1] https://www.fca.org.uk/publication/documents/future-cessation-loss-representativeness-libor-benchmarks.pdf
[2] https://s2.q4cdn.com/154085107/files/doc_news/ICE-Benchmark-Administration-Publishes-Feedback-Statement-for-the-Consultation-on-Its-Intention-to-Cease-the-Publication-of-LIBOR-Set-Z2E0P.pdf
[3] https://www.lseg.com/en/post-trade/clearing/membership/ltd-membership/ltd-member-updates/summary-lchs-consultation-its-solution-outstanding-0
[4] https://secure-area.lchclearnet.com/secure_area/secure/default.asp?folder=6199&view=list ; https://secure-area.lchclearnet.com/secure_area/secure/default.asp?folder=6200&view=list
[5] As defined in ISDA’s Fallbacks Supplement
[6] https://www.fca.org.uk/news/speeches/libor-transition-and-contractual-fallbacks
[7] https://www.isda.org/a/KPZTE/ISDA-Guidance-on-the-UK-FCA-Announcement-on-the-LIBOR-Benchmarks.pdf
[8] For certain product types such as compounding ZCS, further work is required to confirm the treatment
[9] https://www.lseg.com/en/post-trade/clearing/membership/ltd-membership/ltd-member-updates/update-lch-limiteds-position-libor-cessation-and