Having spent the last few years prepping for MiFID II, most European asset managers are now busy concentrating their resources on applying the finishing touches to no-deal Brexit planning.
A handful of forward-looking fund houses are even hypothesising about what the regulatory legacy will be following the Neil Woodford episode, curious to know whether policymakers will use the incident as a launchpad to impose tighter controls on the UCITS liquidity risk management framework.
However, few asset managers have yet to tackle the full impact of the incoming Libor reforms, namely the transition to alternative risk-free rates. Currently, Libor is the reference rate for $350 trillion of financial instruments, including derivatives, bonds, securitisations, loans and some residential mortgages.
“Numerous buy-side firms are not sufficiently aware of the impending Libor changes. Many institutions are simply waiting for their bank counterparties to instigate the preparation process,” acknowledged Jonathan Gilmour, partner and head of derivatives and structured products at law firm Travers Smith.
Libor’s retirement – which is scheduled to take place at the end of 2021 at the behest of the Financial Conduct Authority (FCA) – is a massive challenge for global asset managers. It matters to the buy-side for several reasons. Firstly, many funds will have exposure to instruments referencing Libor for hedging purposes while others – mostly those operating alternative or fixed income strategies – will use it as a benchmark to measure performance. And finally, Libor is often leveraged by managers, fund administrators and custodians as an input into their various risk calculations and valuation models. A failure to update legacy contracts ahead of Libor’s termination could have serious operational and investment risks.
“Most asset managers are not yet repapering their contracts, but rather waiting to see what solutions the industry bodies – whether it be the International Swaps and Derivatives Association (ISDA), the Loan Market Association (LMA) or others – come up with in terms of amending legacy contracts. Once this becomes clear, I expect custodians will begin to help asset managers with the transition process,” said Gilmour.
Nonetheless, there are a number of challenges. While several industry associations are working together to reach consensus on fallback provisions for different financial instruments, divergences could easily emerge, leading to inconsistent approaches being adopted across multiple asset classes.
Conscious of the growing buy-side uncertainty about Libor reform, asset management bodies have published guidance too. The Investment Association (IA) in conjunction with consultants Oliver Wyman released a paper advising managers on how to best navigate the Libor transition. Among the publication’s recommendations were that fund managers identify and mobilise resources to address the transition process; start communicating