1.      LIBOR history and overview

The London Interbank Offered Rate (LIBOR) was officially adopted in 1986, with roots dating back to the 60s. At its peak it underpinned some $300 trillion of financial instruments and was one of the most widely quoted reference rates in the world, with seven settings (or tenors), ranging from overnight to 12 months, and five different currencies (USD, GBP, EUR, JPY and CHF) for each maturity.

However, a significant decline in interbank lending and some high-profile instances of LIBOR manipulation resulted in the publication of the Financial Stability Board’s (FSB) recommendation in 2014 to develop alternative so-called “risk-free” rates (RFRs) for use instead of LIBOR and other Interbank Overnight Rates (IBORs).

In July 2017, the former Chief Executive of the Financial Conduct Authority (FCA) Andrew Bailey, said in a speech that “…the underlying market that LIBOR seeks to measure – the market for unsecured wholesale term lending to banks – is no longer sufficiently active.” In the same speech, he added that the FCA would not compel banks to make LIBOR submissions after the end of 2021 which was widely understood as the first indication that LIBOR would cease to exist post-2021.

2.      What is LIBOR being replaced with?

The following RFRs, also known as “alternative reference rates” (ARRs), are the designated replacements to LIBOR:

3.      When is LIBOR being replaced?

On 5 March 2021, the FCA has published a statement announcing the dates that all LIBOR settings will either cease to be provided by any administrator or will no longer be representative. These dates are:

• Immediately after 31 December 2021, in the case of all sterling, euro, Swiss franc and Japanese yen settings, and the 1-week and 2-month US dollar settings; and
• Immediately after 30 June 2023, in the case of the remaining US dollar

The equivalent London Interbank Bid Rate (LIBID) for each setting will end at the same time.

Subsequently the FCA has confirmed that a synthetic LIBOR rate will be published for a period of time for sterling and Japanese yen settings (see section 11: What is Synthetic LIBOR).

4.      Where was LIBOR used at Schroders?

Within financial instruments. LIBOR was used as a reference rate in a wide range of financial contracts, including derivatives, securitisations, bonds and loans. We held these instruments in some of our funds and within some of our clients segregated mandates.

As a fund or mandate benchmarks. LIBOR was used as a comparator or target benchmark for a number of our retail funds and for a small number of our clients’ mandates, including some usage as a component part of a composite benchmark where LIBOR was often used to replicate the performance of ‘cash’. These benchmarks have largely been updated.

In documentation. Some of the documentation to our funds, contracts with clients and some of our other commercial contracts referenced LIBOR, these have largely been updated.

In our operations and technology. LIBOR was used in a number of operational processes and IT systems, including some of our Business Applications and Models, including being used by some of our third-party vendors.

5.      Schroders’ activities in connection with the transition away from LIBOR

Schroders has committed significant resource to make the transition to RFRs as smooth as possible and with minimal impact on our clients and has had a dedicated programme team working with the business on this transition since June 2019. Throughout the transition we have tracked the exposure to LIBOR from the assets we manage on a quarterly basis and worked consistently towards transitioning away from LIBOR where practicable and where it is in our clients’ best interests.

We have had regular dialogue with the FCA and the PRA on LIBOR transition and have actively participated in several RFR Working groups and other industry fora, responding to many of the industry wide consultations regarding LIBOR transition where we have believed it to be in our clients’ interests to do so.

6.      What does the transition mean for Schroders’ clients?

We communicated to all impacted clients, Shareholders and Unit holders in our mutual funds throughout the transition. Schroders has aimed to minimise the impacts of LIBOR transition and we anticipate that the majority of our clients will not have noticed any difference.

7.      How will transition work for underlying investments referencing LIBOR?

We hold a number of securities that reference LIBOR in our mutual funds or in the investments we make for, or on behalf of, our clients. Different instruments have a number of different transition paths after LIBOR cessation, dependent on the instrument type and the setting of LIBOR they reference

Derivative positions to settings ending 31 December 2021:

• Cleared We have actively transitioned all Cleared Swaps that reference a LIBOR setting ending in 2021.
• Over-the-counter We only hold Bi-lateral Interest Rate Swap and Non-Linear derivative positions for one client and have discussed their transition path with this client.

Derivative positions to settings ending 30 June 2023:

• Cleared swaps. We hold a small number of Cleared USD LIBOR swaps that mature post 30 June 2023 in some of our funds and clients’ mandates and there is the possibility that we will actively transition out of these positions before USD LIBOR It is anticipated that the Clearing Houses¹ will announce their plans for USD LIBOR transition sometime in 2022. If the Clearing Houses proceed as they did for the LIBOR settings ending in 2021, they will transition all positions to SOFR shortly before USD LIBOR cessation and provide cash compensation payments where applicable.
• Over-the-counter derivatives. We still hold Bi-lateral Interest Rate Swap positions in a number of our funds and clients’ These contracts are governed by International Swaps and Derivatives Association (ISDA) documentation and as Schroders have adhered to the ISDA IBOR Fallback Protocol as agent on behalf of its clients and funds, these positions have a known fallback² to SOFR with a ‘Spread Adjustment’³ if we do not actively transition.

Cash product positions to settings ending 31 December 2021:

We still hold a small number of Corporate Bonds, Floating Rate Notes and Securitisations that reference LIBOR settings ending 31 December 2021. There are broadly three main ways these investments will transition:

• Active transition. This is the change of a security from referencing LIBOR to referencing an RFR before LIBOR cessation. As a buyer of securities, rather than an issuer, we are reliant on security issuers carrying out consent solicitations or other corporate actions to change their securities. If the required amount of noteholders consent, these products transition from LIBOR to an alternative benchmark. There has been active transition of a number of our bonds and securitisations over the period of transition and it is still possible that some securities could transition this way even after LIBOR
• Many contracts, particularly those issued post-2018, have fallback provisions written in them for when LIBOR ends. However, as cash products do not have standardised language like derivative contracts, there are many different types of fallback language. We have reviewed the relevant prospectuses and indentures to understand the fallback provisions and the transition path of each security.
• Alternative transition mechanisms. Both the U.K and EU have developed alternative mechanisms for transition:
  • United Kingdom. Synthetic LIBOR (see section 11. What is Synthetic LIBOR). The FCA has confirmed that sterling and yen LIBOR rates may continue, on a temporary basis, to be used in certain legacy LIBOR contracts that have not been remediated at or ahead of end-31 December In practice this means that unless there is a specific fallback trigger in the contract, all our securitisations and bonds that continue to reference GBP LIBOR will use the new synthetic rate for as long as it is published.

• European Union. The European Commission has in October 2021 published two Implementing Acts to the Benchmarks Regulation, designating spread-adjusted SARON-based replacement rates for CHF LIBOR and spread-adjusted €STR-based replacement rates for EONIA4 where there is no fallback

Cash product positions to settings ending 30 June 2023:

We hold a number of Corporate Bonds, Floating Rate Notes and Securitisations that mature post 30 June 2023 and reference USD LIBOR. With a period of time until USD LIBOR cessation, there is a chance we may divest from some of these securities before LIBOR cessation. For those that we continue to hold there are three ways these investments could transition:

• Active transition. There is less likely to be active transition of USD LIBOR securities as consent thresholds are normally higher and often unanimous consent is required, so that it is unlikely that the issuer of that bond will obtain the requisite consent if that bond is widely held in the market. Also for many of our securitised holdings, remediation and refinancing are not possible outcomes.
• More recently issued contracts are again more likely to have fallback provisions and we have reviewed all prospectuses and indentures to understand the fallback provisions.
• There are two main legislative changes in the U.S. that seek to assist LIBOR transition. Firstly a New York State Law was passed on 6 April 2020. This new legislation will amend contracts with no fallback language or inadequate fallback language, by operation of law, to include the Alternative Reference Rate Committee (ARRC) recommended fallback rate, which is SOFR, plus a spread adjustment. The second legislative change is yet to be approved⁵ but the Adjustable Interest Rate (LIBOR) Act of 2021 has been introduced to the Senate and publication of a new federal law seems imminent. This law is similar to the New York State Law and seeks to establish a clear and uniform nationwide process for replacing USD LIBOR in existing contracts when the terms of the contract do not provide a clearly defined or practicable replacement benchmark rate.

8.      Fund and mandate benchmark transition

For Schroders’ fund range all fund benchmarks have either already transitioned, or changes have been communicated to shareholders and will occur at year end for those funds using LIBOR as a performance fee hurdle⁶.

Where funds mandates still use LIBOR benchmarks these will also need to be updated and we are working with our clients to set new benchmarks and transition in advance of LIBOR cessation dates.

As well as RFRs, other benchmarks are also being used as replacements for LIBOR where more appropriate. As an example, in our fund benchmarks, we have chosen U.S. Treasury Bills (T-Bills) or UK government bills in most instances as the most appropriate replacement rate for this use of LIBOR.

9.      Changes to documentation

We have reviewed and remediated, where relevant, all of our IMAs and other legal documentation. We have also updated product documents such as prospectuses, KIIDs or other marketing materials that referenced LIBOR.

10.  Operational changes

There are no critical risks posed to our business from the operational changes required to transition from LIBOR and we have conducted extensive engagement with our third-party vendors to understand their plans and incorporate into our transition plan. We have ensured our technology systems have the capability to handle investments in new RFR instruments and where any potential issues have been identified, we have plans in place to ensure that any impacts are minimised.

11.  What is Synthetic LIBOR?

The FCA confirmed on 16 November 2021 that it will allow the temporary use of synthetic sterling and yen LIBOR rates in all legacy LIBOR contracts, other than cleared derivatives, that have not been changed at or ahead of end-31 December 2021. These synthetic rates will not be available for use in any new contracts, so any new cash product we invest in, or interest rate swap or other derivative contract we enter into, will reference an RFR.

Sterling synthetic LIBOR will be calculated as the sum of the 1-, 3- or 6-month Sterling Overnight Index Average (SONIA) reference rate provided by the ICE Benchmark Association (IBA) and the ISDA spread adjustment for and published as a “screen rate” by IBA.

The FCA have confirmed that synthetic LIBOR will be available for a maximum of 10 years for GBP LIBOR⁷, and that its publication will be reviewed on an annual basis, it should thus be seen as a temporary bridging solution only. For our investments it will only be used for a small number of bonds and securitisations that are already floating against GBP LIBOR and have not actively transitioned.

12.  Are there risks for investors resulting from the LIBOR transition?

We have worked to minimise all the impacts of LIBOR transition for our clients and have proactively worked alongside other market participants to bring about an orderly transition. However, there is arguably an inherent risk of market disruption in any significant transition exercise that impacts a significant number of market participants and instrument types.

The conversion from a LIBOR-linked product to a RFR-linked product will at times result in a payment being made from one party to the other to account for the change in the characteristics of the underlying reference rate. While the use of industry developed methodologies (such as those developed by ISDA for the derivatives markets) to calculate the new reference rate should help to minimise this value transfer it will not remove it entirely.

13.  By what date will Schroders stop referencing LIBOR for new business?

Schroders is committed to meeting the milestones set by the FCA and other global regulators and will not be entering into any new derivative positions referencing LIBOR settings ending 31 December 2021. Even in the USD LIBOR settings that are continuing to a later date, we are already not entering into new contracts that use USD LIBOR as a reference rate where practicable and will not enter any new contracts from 31 December 2021.

14.  Where can I find more information?

Please contact your Schroders client services representative for any further information and to discuss any questions you may have.

1 We hold Cleared Derivatives through the London Clearing House (LCH).
2 ISDA published a statement confirming the FCA announcement on 5 March 2021 was an index cessation event under the IBOR Fallbacks Supplement and Protocol for all 35 LIBOR settings and thus set the future fallback rates.
3 ‘Spread adjustment’ is a credit spread adjustment which is intended to allow for the bank credit-risk element embedded within LIBOR which is not factored into the calculation of a RFR. This is calculated as a 5-year average of the spread between USD LIBOR and SOFR until the discontinuation of LIBOR.
4 A second European reference rate, the Euro Overnight Index Average Rate (EONIA), is also subject to cessation at the end of 2021 and will in most instances be replaced by “Modified €STR” i.e. €STR plus an 8.5 bps spread. Some parties in the market will directly use €STR (without a spread) as their chosen replacement rate, in which case this will be supplemented on the transition date with a one-off balancing (or “compensation”) payment.
5 As at 30 November 2021 this Act was in draft form and publication is expected imminently
6 SISF Funds European Alpha Absolute Return; European Equity Absolute Return and Sustainable European Market Neutral
7 It will also be available for one year for JPY LIBOR, but this has no impact for our clients

Glossary

Active transition – the transition of a security from LIBOR to an RFR before LIBOR cessation.

Alternative Reference Rate Committee (ARRC) – a group of financial industry participants focused on the successful transition from United States Dollars (USD) London Interbank Offered Rate to an alternative rate.

Benchmark – a standard against which the performance of a financial asset or a fund can be measured. Benchmarks are used in our funds for a range of purposes including a standard against which to compare the return or “performance” of the fund, as a target for the fund’s returns to outperform and for defining what types and amounts of financial assets the fund will invest in. In some instances, they are also used to calculate performance fees, being fees that are paid to the investment manager of the fund if the fund’s performance rises above a set threshold.

Bonds or Notes – a form of financial asset that represents a loan from a financial investor (the bondholder or noteholder) to a borrower called the “issuer” (usually corporates or governments).

Clearing House – a designated intermediary between a buyer and seller in a financial market, e.g. the London Clearing House (LCH).

Credit Risk – the risk that a borrower will become bankrupt or otherwise fail to repay a loan.

Derivatives – a financial asset with a value that is set by reference to other assets e.g. shares, bonds, interest rates.

Fallback – a contractual term of a financial asset that outlines the alternative rate to be used if London Interbank Offered Rate or Interbank Offered Rate is discontinued.

Financial Conduct Authority (FCA) - the conduct authority for financial services firms in the United Kingdom.

Financial Stability Board – an international body that works to promote international financial stability.

Floating Rate Notes (FRN) - a note (see above) with a variable rate of interest that resets at specified intervals.

Interbank Offered Rate (IBOR) - a rate at which major global banks expect they can borrow from other major global banks. This is often not based on actual loans between those banks but is created from estimates submitted by those banks.

ICE Benchmark Administration (IBA) - administrators of regulated benchmarks, including LIBOR.

Interest Rate – the amount a lender charges a borrower for a loan.

International Swaps and Derivatives Association (ISDA) - a trade association representing participants in the derivatives market.

London Interbank Bid Rate (LIBID) - an indicative rate that banks lend to other banks. LIBID is not published by IBA, but is accepted as being LIBOR minus 0.125%.

Maturities - represents the number of days before a financial asset must be repaid.

Note – see bonds above.

Noteholder consent – a process whereby the issuer of a note has to obtain the consent of a certain percentage of the noteholders before the terms of that note can be amended.

Over-the-counter derivative – a derivative entered into bilaterally between two parties and not traded on a derivatives exchange.

Portfolio – a range of investments held by a person or company.

Reference Rate - an interest rate benchmark used to set other interest rates in financial assets. London Interbank Offered Rate and Interbank Offered Rates are examples of reference rates.

Risk Free Rate – a reference rate that does not include in its calculation the credit risk of the borrower.

Synthetic LIBOR – LIBOR’s continued publication, under a new methodology, on the same screen that can be used for legacy contracts only

Swaps – a type of derivative between two parties to exchange the cash flows or liabilities of two financial assets for a defined period.

Important Information: This document should not be considered as legal or regulatory advice or relied upon as such. We encourage all our clients to seek independent legal advice in respect of their legal and regulatory obligations.