LIBOR transition update: In flight
The head of Wells Fargo’s LIBOR Transition Office discusses the status of the industrywide effort to replace one of the most widely used financial benchmarks.
Editor’s note: In August 2019, Brian Grabenstein, head of Wells Fargo’s LIBOR Transition Office, provided a primer on the LIBOR transition currently underway in the financial services industry. The effort is focused on replacing LIBOR, a benchmark rate that underlies the vast majority of floating rate financial transactions, with a new alternative. With the scheduled deadline set for year-end 2021, Grabenstein discusses how the effort is progressing, particularly in light of the COVID-19 pandemic.
As the LIBOR transition deadline approaches, what progress has been made across the industry?
A lot is happening at the industry level. The main body tackling U.S. dollar LIBOR is the Alternative Reference Rates Committee (ARRC), which consists of a few dozen market participants — including Wells Fargo — as well as pretty much every national regulator. The ARRC meets monthly, and it recently published its objectives for 2020, which commit it to a fairly ambitious agenda for the rest of 2020 and into 2021. That includes finalizing the work on the spread adjustment for cash products and working with market participants to help transition derivatives to the Secured Overnight Financing Rate (SOFR), the recommended alternative to LIBOR in the U.S. There’s also lot of work going on about finalizing what we call “fallback language,” which is the contractual provision that lays out the process through which a replacement rate can be identified if LIBOR is not available. The final fallback language for student loans will be finished soon, and all other fallback language was finalized in 2019.
What progress has Wells Fargo made in its preparation for the transition?
We’ve done a lot. There are hundreds of people throughout Wells Fargo right now working either full- or part-time on the LIBOR transition. This includes employees from our corporate and investment bank, wealth management, commercial bank, and consumer and small business banking. In a little more than two years, we put in place and mobilized a very thoughtful governance and operating structure that regularly reports to our Steering Committee, comprised of members of the Operating Committee, as well as other senior governance committees, including the Board of Directors.
We’ve spent a lot of time doing an impact assessment of the LIBOR transition. In order to launch a redesigned product that will use SOFR instead of LIBOR, we need to understand what system enhancements need to be made, what the model development and validation will look like, and what contracts and processes need to be addressed. We have a good handle on our exposures, and we understand the interconnectedness of those things. They’ve been mapped out and incorporated into our plan, which we have been executing on for some time now.
We’ve also been reaching out to our impacted commercial clients. We have tens of thousands, if not hundreds of thousands, of clients who are impacted, so the scope is pretty enormous and ongoing.
What impact has the COVID-19 pandemic had on the LIBOR transition effort?
Within Wells Fargo, we’ve seen a very limited impact on our transition effort. Some employees have had to pivot a bit to help get important things like the Paycheck Protection Program launched, but it has not gotten in the way of our LIBOR transition work. Some smaller institutions have had to redeploy individuals who have been working on the LIBOR transition to more COVID-related work, so that has had an impact on industry readiness.
With that said, I think a lot of the market is pointing to COVID-19 as the reason why they need additional time. One could speculate that maybe they weren’t going to be ready as it was and COVID-19 provided an additional challenge during an already complex transition. What’s important about that is this is a very interconnected effort, so we’re impacted by the rest of the industry.
Is the financial services industry still targeting the end of 2021 as the timeframe to transition to an alternative reference rate?
The message coming from the regulators has been crystal clear — they have no plans to extend the deadline. The Financial Conduct Authority, which regulates the organization that publishes LIBOR, was the first to come out and reaffirm the importance of maintaining the end of 2021 deadline. Subsequently, the Financial Stability Board actually did an assessment of everything it has asked banks and other market participants to focus on, and it affirmed LIBOR as one of a small subset of things that couldn’t be delayed. So, the situation is clear.
Is SOFR still the most likely replacement for LIBOR? Has SOFR shown any unexpected weaknesses?
SOFR is still the replacement for U.S. dollar LIBOR; that hasn’t changed. I think it’s a well-understood rate; certainly much more so than it was a year or two ago. We now actually have two years of real trading data. There have been a few times when market events have caused SOFR to have some intermittent volatility. But even with those periods of volatility it worked as expected, so I think SOFR has proven itself out.
There are many who want to write the story that SOFR won’t work. Some of that is based on the volatility. Some of it is because, unlike LIBOR, SOFR doesn’t have a credit-sensitivity element to it. Meaning, because it is based on the U.S. Treasury repo market, SOFR represents a “risk-free” rate.
People are still debating, five years too late arguably, whether we can come up with a rate more like LIBOR. And remember, the ARRC spent the better part of three years soliciting market feedback and developing their recommendation to use SOFR. Perhaps other rates may emerge in the future, but I find it hard to imagine that any rate is going to emerge in the near term that will be usable prior to the end of 2021, or one that will be compliant with international principles and supported by the official sector. So, for now, we are operating on the assumption that it’s 100% SOFR.
How have other countries been progressing with the LIBOR replacement for their respective currencies? Are they under the same deadline as the United States?
The short answer, yes and yes. All LIBORs — and remember, there are LIBORs in five major currencies (U.S. dollar, pound sterling, euro, Swiss franc, and Japanese yen) — have the same deadline of the end of 2021. That is because LIBOR, in all its currencies, is under the oversight of one regulator, the UK Financial Conduct Authority. Each currency jurisdiction has identified its recommended alternative rate and has been progressing in their transition work. Some jurisdictions are ahead of others, like the UK, which recommended an alternative rate that has been published since 1997, the Sterling Overnight Index Average (SONIA). Other currencies like the U.S. dollar or euro have recommended newly published rates, which require greater market education.
What has been the most challenging aspect of preparing for the transition?
At Wells Fargo, we’ve had to mobilize an enormous amount of people from across the enterprise at a time when we have so many other things to focus on, and still do. Projects of this scope take time, but we have made a lot of progress.
From an industry perspective, the regulators told us, in general, we need to be ready for a world without LIBOR by year-end 2021. There were no specific guidelines. The Alternative Reference Rates Committee has 35 or so participants, plus another dozen from the official sector. If you ask four dozen people to agree on anything, it’s going to take some time. Ask them to agree on what is effectively 20 things, each of which has a high level of specificity and a significant impact associated with them — that’s a Herculean undertaking.
The ARRC, which aims to represent all market participant voices, was essentially asked to decide among itself how to reinvent floating rate lending, borrowing, issuing, and investing. Organically, the development of a market like that would take a decade or more. We as a market have been asked to figure it out and actually execute on it while we’re figuring it out. With the backdrop of this having so much impact, that to me has really been the most challenging thing.
What has Wells Fargo been doing to inform clients of how they might be affected? Has the company provided any feedback or shared any concerns?
Throughout last year, we did an extraordinary number of in-person roadshows with clients. There were close to 60 presentations in 45 cities. Commercial clients were asking for in-person meetings, so we really took to the road. There is a lot of detail that goes into this transition, and it’s not necessarily a simple explanation, so we felt it was really important that we got in front of our clients. We knew that this was just going to be the first of many conversations to help them understand the changes and the potential impacts. Additionally we recently launched an external Transition from LIBOR site with information to help inform our customers about the transition. Our employees within Wells Fargo also have an internal site with all the resources they need.
In the COVID-19 era, we’ve turned to virtual outreach. We held our first large event in April. We had in excess of 1,100 individuals dial in, more than half of whom were clients. The general feedback has been, “What does this mean for my interest rate?” “How does this impact me from a dollar perspective?” While we don’t have all the answers yet, part of our goal is to help our customers understand what the market is thinking, how it is structuring itself to migrate legacy contracts, what that methodology looks like from a calculation standpoint, and really just how to think about SOFR as it differs from LIBOR. A lot of people, understandably, don’t like change. But that’s where we are. We have to embrace change when it’s presented. That’s also been part of the conversation.
What metrics are being used to gauge how prepared the financial services industry is for the upcoming transition?
The Alternative Reference Rates Committee recently published a set of best practices. It would have done so sooner if not for the COVID-19 pandemic. Those best practices essentially set sunset dates for LIBOR-based products. Meaning, the committee has publicly stated that it thinks that no market participant, as a matter of best practice, should be issuing LIBOR-based loans after a certain date, June 30, 2021, for most products. So within just over a year, the committee is saying it doesn’t want to see anymore LIBOR-based lending.
Overall, do you expect the transition away from LIBOR will be a smooth one?
From a company perspective, I’m very encouraged by the fact that we have the plans in place, we have the resources mobilized, and we’re executing. But frankly, I think it is going to be a challenging undertaking because the industry as a whole hasn’t progressed as much as we would have liked, and COVID-19 is going to make it extra challenging. We’ve heard loud and clear from the regulators that the deadline is the deadline so I’m cautiously optimistic. We’ll land the plane, but it may get a little bumpy on the way down.