Why Asian firms expect a major systems and data overhaul

In this feature, Bing Li, head of Asia‑Pacific, and Steffan Tsilimos, global head of interest rate derivatives products at Bloomberg, explore the implications of the Libor transition on the Asia markets and the broader market impact of the transition

BIng Li, Bloomberg

The wide-ranging impact of the move away from the use of Libor to risk-free rates (RFRs) on financial institutions and corporates is a well-known fact. It involves a fundamental change in the underlying interest rates used in all kinds of instrument and asset classes, which affects how financial institutions and corporations operate. As such, firms will need to overhaul their systems and data management to calculate new profit and loss (P&L), manage risks and get pricing, among other considerations.  

The state of readiness among financial institutions and corporations in the Asia‑Pacific region (APAC) for this fundamental change varies. “Some Asian jurisdictions are more advanced than others, while market participants in the derivatives and cash markets vary in their state of preparedness. Many of our sell-side clients, for example, began planning for the Libor transition much earlier than corporates, given their market exposure,” says Bing Li, head of Asia‑Pacific at Bloomberg.

However, an increasing number of corporations are starting to examine how they can be better prepared for the transition, driven largely by regulatory imperatives. The Australian Securities and Investments Commission sent a “Dear CEO” letter to companies in May 2019, urging them to begin preparing for the transition, and the Bank of Japan and the Japanese Financial Services Agency have also made similar requests. 

The derivatives market in Asia is generally better prepared for the adoption of RFRs because of support from the International Swaps and Derivatives Association (Isda), which has provided frameworks, guidelines and protocols to facilitate the transition. For example, Singapore is making significant progress in preparing for the transition from the Singapore dollar swap offer rate (SOR) to the Singapore overnight rate average (SORA). According to the Association of Banks in Singapore, the majority of banks in the SOR‑SORA Steering Group are ready to trade SORA derivatives, while making good progress in other asset classes. Even so, much remains to be done – regionally and globally.

“For bilateral uncleared portfolios, clients can ‘repaper’ or negotiate revisions to existing Isda agreements and credit support annex (CSA) portfolio netting sets. For cleared trades, the central counterparty clearing house (CCP) may conduct multilateral auctions and other protocols to move existing legacy Libor swaps/legs to RFRs. For either bilateral or cleared trades, a ‘close-out’ of existing Libor trades, coupled with a new trade that references the RFR index, may be initiated. Alternatively, a basis trade where the Libor legs offset may be initiated,” says Steffan Tsilimos, global head of interest rate derivatives products at Bloomberg.

 

Cash markets face more challenges

Tsilimos also noted that participants in the cash market face a different set of challenges. One of the biggest of these is the fallback language for legacy issuance, which did not exist in many cases or is vague and disparate across issuers. Converting existing securities from Libor to RFRs is another challenge. Market participants are dependent on issuers or custodians to initiate such a move, which requires consent from investors holding the securities. While investors may want to sell out of positions where the fallback language is vague or missing, markets for these securities may be less liquid than those with well-defined fallbacks.

Steffan Tsilimos, Bloomberg

Consensus on fallback rates for cash products is also difficult to obtain as these securities are also traded in the retail market, which can comprise more than two parties, unlike interest rate swaps, according to Tsilimos. For example, a typical mortgage product involves the mortgagee, mortgagor, custodian, issuer and investor. 

Assessing the fallback language in the original documentation for cash securities is a key consideration, but such language is sometimes absent, or not applicable in a situation when Libor ceases to be in use. 

“Given the nature of each security having its own unique legal documentation, assessing the fallback language for every security in a portfolio can be a formidable task. A consent solicitation can be difficult or may even fail, in part due to the potential value transfer,” he added. 

 

Assessing fallback ramifications

Bloomberg offers tools to identify fallback language for cash securities, which enable asset managers and other institutional investors to assess fallback ramifications. 

“Bloomberg has mined cash security documentation across a range of cash securities, including floating-rate notes, municipal securities, securitisations, preferred securities and syndicated loans, to locate fallback language where available. This fallback language is available through a set of new fields that can be viewed in accordance with the [Bloomberg] Terminal licence or downloaded for enterprise use via a data licence,” Tsilimos says.

Currently, Libor fallback language is disparate across counterparty pairs. The upcoming fallback methodology will allow for a smooth transition for counterparties that opt in to the upcoming Isda protocol. Bloomberg Index Services was selected by Isda to calculate and publish adjustments related to fallbacks based on the exact methodology and parameters determined through industry consultations.

The calculations of fallback data and fallback language will be integrated within the Bloomberg analytics and portfolio solutions to support Libor transition globally.

“Bloomberg’s derivatives analytics solution, coupled with execution and order management platforms, enables users to assess valuation and risk ramifications, as well as seamless execution for Libor transition portfolio changes,” Tsilimos says.

The Bloomberg Terminal can support the pricing of derivatives, referencing RFRs. To execute RFR-based derivatives that are being traded electronically, financial institutions and corporations can leverage Bloomberg’s Swap Execution Facility (BSEF) and its UK and Netherlands Multilateral Trading Facilities (BMTF and BTFE).

 

Assessing dependencies on Libor

Financial institutions and corporations will also need to take a closer look at their Libor dependencies and actively consider effective approaches that will match their needs, Tsilimos noted. 

“They must begin testing portfolios and analysing risk to help ensure the transition goes smoothly. The process can include impact analysis on changes to Isda agreements, preparing for price alignment changes at the CCPS, and running what-if analysis on risk and valuation changes associated with migration of derivatives over to RFRs,” he says. 

 

Performing what-if analysis

As RFRs gain momentum, financial institutions and corporations need to understand the impact on valuation and risk for their cleared and bilateral portfolios, Tsilimos says. The Bloomberg Multi-Asset Risk System (MARS) application programming interface (API) enables institutions and corporates to perform what-if analysis to understand the P&L implications and risk impacts on portfolios under different scenarios such as changes in price alignment interest at CCPs, repapering CSAs to include new RFRs or analysis of an early migration to RFRs. 

The MARS API is also optimised to reflect real-time market observations, resulting from a single data snapshot, which ensures full transparency and confidence when restructuring existing contracts to mitigate risks from the transition. 

 

Addressing operational challenges

In addition, Bloomberg Terminal functions address a number of operational challenges posed by uncertainty after 2021. For example, the Terminal supports RFRs when looking for information on new securities, yield curve analysis or electronic trading. 

“Clients are able to conduct various functions and access tailored solutions based on individual portfolio needs, such as monitoring growth in cash securities and RFR-based derivatives, as well as derivatives pricing and risk analysis,” Li says. 

The Bloomberg Terminal also supports compounded interest rate calculations for the loans market. In discussing how Bloomberg continues to support clients in APAC, Li notes: “A common problem for banks in the region is how to fix and calculate the interest rate for floating rate cashflows.

“We worked with a Japanese bank to create workflows involving the input of trade data using several channels and new calculation methods to help them tackle this issue. We can replicate such workflows for banks in the region due to our ability to collect and harness various types of data and help our clients make sense of it, for pricing and risk calculations,” he added.

“The transition is no doubt complex as systems and data management have to be overhauled to perform fundamental tasks such as calculating P&L and managing risk. The rapid implementation of relevant technology will be key. Bloomberg has developed a range of hosted solutions across data, risk and trade execution to help market participants prepare for the end of Libor in 2021,” Li concludes.

 

Libor Risk – Quarterly report Q2 2020
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