Life after LIBOR – Schroders’ plan
With LIBOR’s reign as a key fund benchmark coming to an end, we explain Schroders’ plans to replace it and what it means for portfolios.
It is expected that LIBOR - the London Interbank Offered Rate - and some other Interbank Offered Rates (IBORs), will cease to exist after the end of 2021. These widely-used measures are estimates of the rates of interest that banks charge each other for short-term loans.
In 2014, the Financial Stability Board (FSB) – a Swiss-based international body - recommended that alternative “risk-free” rates (RFRs) be developed to replace LIBOR and other IBORs. This followed a period of significant decline in interbank lending and some high-profile instances of LIBOR manipulation.
Following the FSB’s recommendation in 2014, industry working groups were established to develop the new RFRs (also known as “alternative reference rates”) that are expected to replace LIBOR and some other IBORs after the end of 2021.
As one of the most widely referenced rates in the world, LIBOR’s replacement is a meaningful topic for investors, and one we have been closely engaged with for some time.
Here we explain Schroders’ chosen replacement for fund benchmarks and how we expect it to affect portfolios.
How are benchmarks currently used at Schroders?
Across our range of funds, and within the portfolios we manage for our clients, we use a number of different benchmarks. This is due to the global nature of our business, the number of clients we work with, as well as the breadth of our range of funds and solutions.
The benchmarks are used for a range of purposes, including comparison, as a target, for tracking purposes and for defining asset allocation. In some instances, they are also used to calculate performance fees.
In particular, we use multiple LIBOR benchmarks (and other discontinuing IBORs), whether in pure form or as part of a composite benchmark. These benchmarks often contain a spread (e.g. LIBOR +2%). In the Schroder International Selection Fund (SISF) range, for example, 24 out of 137 funds contain LIBOR benchmarks.
What action is Schroders taking to assess benchmark replacements for LIBOR?
We recognise the importance of the industry-led transition to RFRs and are aware that the impact of the transition will not be the same for all investment funds and portfolios that we manage.
Schroders has been planning for the effective management of the impact this transition will have on our clients’ investments with us. This process has included participating in industry working groups, such as the Bank of England’s Working Group on Sterling Risk-Free Reference Rates.
We are undertaking a number of steps to respond to the discontinuation of LIBOR, including the review of segregated clients’ mandates and the review of ordinary share classes in advance of any changes.
Our investment teams have conducted detailed research on the a range of possible replacements and assessed the impacts on our clients of these changes.
Which benchmarks have been selected?
We have selected Treasury Bills (T-Bills) in most instances as the most appropriate replacement rate for LIBOR in order to maintain continuity for our clients and our firm.
What do Treasury Bills offer as a benchmark?
We have decided to use benchmark indices which track the performance of UK Government Bills (gilts) and US T-Bills for products with tenors of one month and over. The decision to use T-Bills was primarily based on the need to have a replacement rate with a robust and lengthy track record in the market.
We believed that it was also important to identify a replacement which our clients and our investment teams could instantly recognise. Gilts and T-Bills are widely-available financial instruments and investable assets in their own right. Another significant factor which influenced our decision is that indices for UK Government Bills as well as T-Bill indices are available from an established and trusted benchmark administrator, Intercontinental Exchange (ICE) Bank of America Merrill Lynch (BofAML).
How can Risk-Free Rates be used?
For shorter-dated LIBOR benchmarks, those of one-month and below, and for London Interbank Bid Rates (LIBID), our view is that Risk Free Rates (RFR) would seem to provide the most appropriate alternative.
T-Bill indices are not as suitable a replacement for very short LIBOR tenors, especially in some currencies where three months is the shortest index available, because in these instances they do not provide a comparator for very short-dated or over-night deposits. This means that RFRs, the majority of which are only available in over-night form, provide a more suitable replacement.
Money market funds are an example of a type of fund that suits RFR benchmarks; these funds invest heavily in money market instruments, very short-dated and overnight deposits and so their performance is best compared against the respective RFR where the majority of their investments are made.
Here, we are transitioning funds to the respective RFRs to the LIBOR currency that they are currently based on. For example, for a GBP LIBID benchmark, we would move to SONIA (Sterling overnight index average) while, for an overnight USD LIBOR benchmark, we will be transitioning to a SOFR (Secured overnight financing rate) benchmark.
When will fund and mandate benchmarks transition?
For our fund ranges, we are implementing the transition over the next 12 months. Our intention is to transition, where possible, all funds and mandates between June 2020 and June 2021. The timing of individual fund and mandate transition will depend on factors such as product lifecycles and on bi-lateral conversations with clients.
There are also further complexities in situations where LIBOR is used within a Performance Fee calculation. We are working through the best transition plans for these funds. Shareholders in funds would be notified in advance of any benchmark changes and from when these will take place. For the segregated mandates we manage for our clients, these benchmarks are set bi-laterally and again we will aim to transition all LIBOR benchmarks within the next 12 months.
Within our investments we are also working towards the transition away from LIBOR by the end of 2021 at the latest in line with market developments, subject to viable alternative investments being available which reference RFRs. We will be contacting our segregated mandate clients to discuss what this means for them from June this year.
 As an example, the ICE BofAML three-month Treasury Bill Index is comprised of a single issue (of the designated tenure) purchased at the beginning of the month and held for a full month. The index is rebalanced monthly and the issue selected is the outstanding Treasury Bill that matures closest to, but not beyond, three months from the rebalancing date.