The Legacy Challenge In LIBOR Transition

November 2, 2020 - 4 minutes
Three corporate professionals chatting in a boardroom

With LIBOR's scheduled sunset looming at the end of 2021, many investors are finding themselves in a difficult situation: what to do with the billions of dollars in bonds currently referencing LIBOR?

TD Securities completed an inaugural par-for-par exchange of legacy LIBOR bonds for the Farm Credit System (FFCB) where "old bonds" were exchanged for "new bonds" with updated LIBOR fallback language. The exchange marks the first-ever public LIBOR reform liability management transaction within the domestic USD GSE, SSA, and IG corporate bond markets. The new FFCB bonds will substantively have the same terms as the old FFCB bonds except for the LIBOR replacement fallback provisions which have been updated to the Alternative Reference Rate Committee's (ARRC) recommended language for LIBOR floating rate notes.

“Our goal in offering the exchange was to remove the unanticipated risk that holders of Farm Credit LIBOR floaters would face with LIBOR’s sunset. By offering a par-for-par exchange, investors were able to retain the floating rate investment they expected with the clarity of ARRC’s fallback language as LIBOR transitions. TD worked thoughtfully and diligently with us to identify the optimal method for meeting that goal,” says Glenn Doran, Managing Director at FFCB.

Partnering with our team, FFCB received both comprehensive research and insights on effective post-LIBOR solutions, as well as our experience of applying suitable alternatives on newly issued bonds. The exchange clearly recognizes FFCB as a proactive issuer who made it a priority to inform investors about the risks associated with the end of LIBOR and offered an effective solution.

Hitting the Ground Running

There was no precedent for a benchmark interest rate to disappear; not to mention the additional challenge of not having specific legislation or regulation dictating how to address any impacted contracts in place. However, that is the current case for the cessation of LIBOR.

When the Financial Conduct Authority first announced in 2017 that there is no guarantee that LIBOR would exist past 2021, our team positioned itself to be at the leading edge of expertise across products and functions. Not only did we focus on legacy cash and derivatives, but we began to trade SOFR swaps and help issuers bring SOFR linked debt to the market. We also launched a serious education and analysis effort via our research team. We knew the impact that LIBOR cessation would have on market participants, and the more we delved into product nuances and details, the more our expertise grew as we uncovered hidden complexities and challenges.

"I would argue that LIBOR might be the most important index in the financial markets encompassing loans, bonds and derivatives," says Priya Misra, Global Head of Rates Strategy. "We knew that replacing LIBOR would not be an easy task and would require focus, teamwork and organization. That has been our mantra since the early days of the post-LIBOR discussions, and it is heartening to see us being recognized as a market leader in this area."

In 2018, TD became the only Canadian bank to join ARRC, a group dedicated to help the industry transition from USD LIBOR to SOFR. This gave us an opportunity to remain focused on the challenges ahead and solutions that included appropriate fallback language and conventions for new SOFR products.

Leading the Way on LIBOR Transition

TD Securities pioneered the first primary market bond issuances using SOFR and SONIA in the U.S. and the U.K. and has remained at the forefront of SOFR issuance. The legacy cash bonds were a challenging issue as the fallbacks could not be modified easily without unanimous consent from all bond holders. The legacy fallbacks were not appropriate and would result in using:

  • A poll of London or New York banks, which carries operational and legal challenges.
  • The last LIBOR rate available, which results in a fixed rate.
"Farm Credit was the first agency issuer to offer investors a solution for their LIBOR bonds," says Eileen Solla-Diaz, Head of Agency Debt Capital Markets. "TD Securities was proud to continue its leadership role in LIBOR reform and act as the sole Dealer Manager and Exchange Agent on this groundbreaking transaction. The 83% participation rate on this exchange clearly demonstrates investors will respond to solutions that address their concerns and needs."

A Blueprint For The Future

For the remaining US$350B in legacy cash bonds linked to LIBOR that exist past 2021 listed on Bloomberg, other banks can view the FFCB exchange as a potential model for their own situations. The widespread support from investors tells us that there is demand from the market, as well as from issuers who may want to remove ambiguity and legal risk. It takes a lot of work to pull it off but is achievable with the right partner.

As regulators increase their supervision and scrutiny of firms' efforts to transition away from LIBOR, liability management exercises to remediate fallback language in legacy LIBOR-linked bonds could play a crucial role in demonstrating to regulators that issuers are doing all they can to minimize their risks and exposures to LIBOR.

ARRC and other regulators have been working on legislation that would address "tough legacy" bonds with inappropriate fallback. However, there is no certainty on if, and when, the legislation will be made into law. The FFCB transaction provides a reliable, post-LIBOR solution that can be used in the interim until concrete legislation addressing LIBOR fallback for tough legacy products is passed.

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