Summary of LCH’s Consultation on its Solution for Outstanding Cleared LIBOR® Contracts
LCH circular number:
16 February 2021
All SwapClear Users
LCH Group (“LCH”), and its SwapClear business, strongly supports the continuing industry-wide efforts to transition from existing benchmarks to risk-free rates (“RFRs”). According to the stated intention of their administrator, LIBOR benchmarks which are published in 5 currencies and which remain in widespread use are set to be discontinued from 31st December 2021 in all but US Dollars. This cessation of the publication of LIBORs would necessitate the adoption of RFRs in their place.
On 15th December 2020, LCH issued an invitation to all SwapClear participants to respond to a consultation regarding the treatment of outstanding cleared LIBOR contracts at or around an Index Cessation Effective Date and their potential conversion into (or replacement with) corresponding RFR-based contracts. This invitation incorporated links to a document which outlined a number of relevant considerations, set out LCH’s proposals for a solution, and requested responses by 29th January 2021. We experienced very active engagement from both members and clients, for which we are grateful, and we are currently processing the large number of responses.
In the consultation, LCH asked ten questions. While analysis of feedback on several of the open questions continues, in the interests of early transparency we are able to provide preliminary results relating to the four questions that required a “Yes/No” answer. These questions asked whether our participants agreed with LCH’s consultation proposals in each of four areas: (i) timing; (ii) standardisation; (iii) spread treatment; and (iv) operational process.
Preliminary Consultation Outcome
LCH asked whether participants agreed that LCH should build and run a conversion process for any LIBOR trades remaining at (or shortly before) a cessation effective date. A majority of respondents answered “Yes”.
LCH asked whether participants agreed that the process should convert remaining LIBOR trades to market-standard RFR trades. A majority of respondents answered “Yes”.
LCH asked whether participants agreed that the spread component should be cash-settled rather than added to (or subtracted from) the existing trade attributes. A majority of respondents answered “No”. The most common reasons provided were: (i) the desire for greater cashflow consistency with ISDA’s fallback outcomes; (ii) a loss of hedge effectiveness; (iii) potential early P&L/income recognition; and (iv) material changes to risk sensitivity. Of those answering “No”, the most popular alternative spread treatment was to incorporate it as a non-compounded spread on the RFR leg of the affected swap contract.
LCH asked whether participants agreed that, from an operational perspective, we should terminate each LIBOR trade before rebooking it as an RFR trade. Again, a majority of respondents answered “Yes”.
Based on this feedback, LCH intends to move forward with a consensus approach of converting outstanding LIBOR contracts into corresponding RFR-based contracts in which:
- LIBOR is replaced by the relevant compounded RFR plus a non-compounded credit spread adjustment in the LIBOR leg;
- observation and payment dates in that leg will follow the current market standard for the relevant RFR contract;
- the non-LIBOR leg of the contract is left unchanged;
- cash compensation is applied to neutralise any small residual valuation difference; and
- from an operational perspective, the process will involve termination of the LIBOR contract and re-booking as an RFR contract.
LCH will plan this event to take place at or shortly before the Index Cessation Effective Date, about which we will be able to be more definitive once the relevant announcements are made by LIBOR’s administrator. Based on current market information, we expect to run a conversion process in late 2021 for CHF / EUR / GBP / JPY LIBOR contracts. Any process for USD LIBOR contracts would occur at a later date. We have also stated that we intend to apply a fee for contracts which experience a cessation event and/or which are subject to the conversion process, so as to support our investment in enhanced service functionality. We expect to be able to share details of our approach shortly.
We will continue to process the responses to remaining consultation questions, and issue further updates in due course. We will engage further with our users to develop any additional technical detail that may be required, and will continue to engage with market participants as we move ahead with this proposal.
Any process will be subject to risk governance review and regulatory non-objection.
Terms used herein and not defined herein have the meaning provided in the LCH Rulebook, FCM Rulebook or in the circulars referred to herein (as applicable). The terms SwapClear Member, SwapClear Transaction and SwapClear Contract include an FCM Clearing Member, an FCM SwapClear Transaction and an FCM SwapClear Contract.
 As defined in ISDA’s Fallbacks Supplement
 Certain minor conforming amendments to trade attributes may be required