Many of the world’s largest corporations are yet to sign up to a crucial derivatives market initiative designed to ease the transition away from Libor, underlining the challenges regulators still face in eradicating the controversial reference rate.
Diageo, Tesla and Walmart are among the companies that haven’t adhered to the International Swaps and Derivatives Association’s fallbacks protocol, a mechanism that allows various Libors to be replaced in old derivatives trades once these rates cease to exist. That stands in stark contrast to widespread take-up of the protocol among financial institutions.
Many multinationals say they are preparing for the Libor transition and some note there are good reasons they haven't signed the ISDA protocol, including Libor's still dominant role in US debt markets. The amount of financial contracts tied to US dollar Libor has actually increased by 12% since 2016 to US$223trn, according to a recent industry report.
But experts warn the broader corporate market, and smaller firms in particular, still have a long way to go if they are going to be ready for various impending deadlines around Libor's demise. Many Libors such as those in sterling, euros and yen will cease to exist at the end of the year.
And despite confirmation that the most commonly-referenced US dollar Libors will be available until mid-2023, regulators have said these rates shouldn't figure in new financial contracts after the end of 2021 and have urged even infrequent swaps users to prepare themselves for the transition.
“There are still a lot of firms that haven’t signed up to the ISDA protocol, either because they’re working out what they need to do or because it hasn't hit the radar yet,” said Edmund Parker, head of the derivatives and structured products practice at law firm Mayer Brown. "We’ve found that when we reach out to buyside clients there is a surprising lack of knowledge about this issue from many."
ISDA’s fallbacks protocol has played an important role in regulators’ efforts to rid markets of Libor, effectively creating a safety net for derivatives trades still linked to the much-maligned lending rate. Nearly 14,000 firms have signed up so far. Around 95% of the interest-rate swaps market is now subject to the protocol, the CFTC said in February.
Most financial institutions have put their name to the ISDA protocol along with a number of non-financial corporations such as Apple, Microsoft and Shell. But adherence is generally far lower in uncleared swaps – an area that includes corporate swap activity. The CFTC said only 69% of this corner of the market is covered by ISDA fallbacks, and there is still a long list of companies yet to join up.
“There are a few active players in derivatives markets that haven’t signed up to the protocol and we understand regulators have been in contact with them,” said Ann Battle, head of benchmark reform at ISDA. “There is also a large tail of corporates that haven’t signed up.”
A number of large UK companies such as Anglo American, BT, Imperial Brands, National Grid, Reckitt Benckiser, Rolls-Royce and Vodafone haven’t adhered to the ISDA protocol. Take-up among US firms appears to be lagging still further behind, with Intel, Comcast, Oracle, PepsiCo and Verizon among the many still to join.
Many of the companies mentioned in this story say they are monitoring the situation and are making plans to deal with the transition. Some also say there are good reasons they have not signed.
"We believe it is premature to do so given that the new risk-free rate for cash products has yet to be determined," a spokesperson for Comcast said, adding that the company always has the option to enter bilateral agreements with swap counterparties directly.
Meanwhile, there is far less evidence of preparations among the countless number of small and medium-sized firms that trade swaps less frequently.
Wait and see
Consultants say the loan market’s reluctance to drop Libor as a reference rate has become a major stumbling block for derivatives users, particularly in the US. The Alternative Reference Rate Committee, a group of private-sector firms working with the Federal Reserve, said in a March report most US banks are continuing to offer Libor as their primary or sole floating-rate loan option.
“Most companies are in wait and see mode,” said Amol Dhargalkar, managing partner and global head of corporates at consultancy Chatham Financial. “A lot of these derivatives are hedging floating-rate liabilities. If they’re not moving to Libor on their loans, why should they move on the derivatives side?”
There is also concern about a lack of liquidity in markets linked to the Secured Overnight Financing Rate, the main alternative to US dollar Libor. Only 4.7% of cleared US dollar swaps referenced alternative rates in March, according to data from ISDA and Clarus, compared with 44.9% in sterling.
Despite these challenges, regulators have said they expect the use of US dollar Libor in new contracts to stop by the end of this year, while the ARCC has set an end-June target date for much of this activity to cease.
“It’s a bit of a reality check for the industry,” said Gerard Jacob, a partner in Accenture’s finance and risk practice. “If firms are going to try and adhere to that best practice [ARCC recommends] they’ve got mountains to climb in a very short period.”