Planning for a smooth transition to a post-Libor world is a significant project-management challenge, and Guggenheim is actively preparing itself and its clients’ portfolios for the transition. As part of its mandate to promote the successful transition away from Libor, the ARRC published a planning guide to help firms prepare themselves, which includes guidance to: Establish program governance; identify and validate portfolio securities’ exposure to Libor; develop product strategy for SOFR replacements; assess contractual remediation impact and design plan; develop operational, technology readiness and risk management plans; and prepare for accounting, reporting, tax, and regulatory effects.
Guggenheim has taken the following steps towards preparing for the transition:
- Implemented a program structure and governance model.
- Established the Libor Transition Core Team (the Core Team) for oversight and coordination.
- Engaged project team leads across functional business groups on their plans, tasks, risks and resources.
- Identified and engaged service providers and counterparties with critical roles in operations and the investing process that will need to be coordinated with our efforts.
- Developed an exposure reporting and monitoring framework with input from sector leads to identify the impacted population.
- Established a legal framework for review and remediation and initiated legal review.
- Created an internal shared portal enabling centralized transparency into the status/progress of the project, analysis, metrics, and reference documentation for the Libor project teams.
The scale and scope of this work is enormous and requires a significant allocation of resources, both during the transition and beyond. Guggenheim’s Core Team, which consists of lead representatives from portfolio management, sector teams, risk, operations, accounting, and legal, holds weekly meetings to steer the direction of the project and prepare update memos for all impacted business groups. The Core Team manages the workstreams of a cross-section of different internal business units to ensure that the many identified project tasks are working toward resolution. In addition, the Core Team engages with multiple third-party relationships, including operating platforms, custodians, administrators, tax systems, data providers, fund accountants, and more to coordinate Libor transition plans.
At the heart of the Core Team’s work on the portfolios is the identification of securities with exposure to Libor and a maturity beyond Jan. 1, 2022. For the thousands of impacted securities and transactions, the principal work is related to determining whether and to what extent the governing documentation contemplates changes to the floating rate in the event Libor (or the key IBOR for other jurisdictions) no longer exists (or ceases to be representative); whether and to what extent changes to such terms are necessary and/or desirable; the manner of dealing with differences in the relative value of the security or transaction in a pre- and post-Libor setting; and evaluating basis risk between cash assets and related hedges, if any. Part of the challenge lies in the fact that this transition to consistent fallback language will differ by product type, because the documentation and governance structures will differ for such instruments as bilateral loans, syndicated loans, floating rate notes, structured products and derivatives.
More and more new issues are carrying language that will be helpful when it comes time to transition. Several collateralized loan obligation (CLO) managers have recently issued deals that automatically convert their CLO liabilities to SOFR if Libor is no longer quoted at a future date, the first of their kind to do so. A crop of new deals is choosing “hardwired” fallback language that dictates that if Libor were to cease, CLO liabilities would automatically fall back to some version of SOFR, plus a spread adjustment (in some cases, an adjustment that will be set out by the International Swaps and Derivatives Association (ISDA) in the very near future). We believe that as more transactions occur with language like this, the adoption rate and transaction volumes will increase.
More Wood to Chop
For market participants, there is more work to be done on both an individual firm level as well as a market structure level. The level of preparedness will vary across asset managers and their clients, service providers, intermediaries, regulators and more. It remains to be seen whether all relevant parties will be ready when the time comes for the transition, and what systemic weaknesses will be exposed if they are not.
From a market perspective, we agree with many commentators who have suggested that acceptance of SOFR-based products is a chicken-and-egg situation. Without a liquid derivatives market, it will be difficult for the cash market to develop, and vice versa. Nevertheless, we expect that volumes of relevant markets will continue to expand.
We will continue to provide updates on the progress we are making toward ensuring a smooth transition to a post-Libor world.