Much more work is needed to mitigate the potential for disruption of the APAC bond markets as a result of the transition from LIBOR to risk free rates (RFRs).
This is based on a new report by Bloomberg and ICMA on ‘tough legacy bonds’ in APAC.
‘Tough legacy bonds’ are debt securities linked to the LIBOR of any currency, due to mature after the cessation of LIBOR in the relevant currency. They have contracts that have no or inappropriate fallbacks, and which cannot realistically be renegotiated or amended.
The announcements made by the UK Financial Conduct Authority on future cessation and loss of representativeness of the LIBOR benchmarks on 5 March 2021 mark an important final step in the successful transition away from LIBOR, said Bloomberg and ICMA. There is now a better understanding of the end game for LIBOR, including the dates for its cessation in different jurisdictions.
Globally, tough legacy bonds comprise $854 billion equivalent across 4,998 issuances, according to Bloomberg data. In APAC, they comprise $190 billion equivalent across 560 bonds, mostly in Japan, China and Australia, which together account for approximately 95% of the total APAC volume.
“The tough legacy bond problem in Asia-Pacific is not insignificant, with 80% of tough legacy bonds having inadequate fallbacks, or no fallbacks at all,” said Mushtaq Kapasi, chief representative for ICMA in Asia Pacific.
“The transition away from LIBOR will require issuers and investors to review their existing LIBOR-linked bond documentation to assess what kind of fallbacks they contain, and consider what actions need to be taken,” he added.
According to the Bloomberg data, as of 1 February 2021, 309 of those 560 bonds (55% of tough legacy issuances) have fallback language in place. Of these, 196 bonds (35% of tough legacy issuances) have only a ‘market disruption event’ trigger, which would not contemplate the permanent cessation of LIBOR. Another 251 bonds (45% of tough legacy issuances) do not have any fallback language at all. Taken together, this figure of 447 (or 80% of tough legacy issuances) becomes quite significant.
“Prior to our report, publicly available data has been generally based on individual national markets or sub-markets, and difficult to aggregate or reconcile. We hope this new extensive analysis will help market participants and supervisory authorities develop more efficient strategies to address the tough legacy bond problem in APAC,” said Bing Li, head of APAC at Bloomberg.
The report noted that the best way to minimise LIBOR transition risks is not to issue new bonds linked to LIBOR, and the GBP and USD markets have responded to this with prolific use of the relevant RFRs for new issues of bonds and securitisations.
But if LIBOR-linked issuance is unavoidable, fallbacks for new issuances of USD LIBOR and JPY LIBOR have been recommended. However, issuance of new LIBOR-linked bonds is continuing in APAC, in some cases without the recommended fallbacks in place. From 2019-20, $12 billion of new issuances had no fallback language.
Methodologies and conventions to accompany new RFRs are keeping pace, and publication of RFR indices may make it easier for market participants to use the various RFR compounding methodologies. And while underlying systems and infrastructure may need to be upgraded, issuers and bondholders are largely able to accommodate the new rates, including their in-arrears methodologies and associated conventions.
Added Li: “It is essential that market participants have adequate systems and infrastructure in place to manage the transition from LIBOR, not only for tough legacy, but also for new issuance and investment linked to RFRs, as there are important fundamental differences between IBORs and RFRs. New calculation methodologies and their associated conventions will need to be facilitated, while trading and liquidity risks have to be adequately considered.”
