« Exchanges at Goldman Sachs

LIBOR's Long Goodbye

2018-10-29

This episode is all about the London Interbank Offered Rate, or LIBOR as it's commonly called. Beth Hammack, Goldman Sachs' global treasurer, and Jason Granet, head of the firm's LIBOR transition efforts, discuss what LIBOR is, what went wrong with the interest rate and now why and how the financial industry is moving to an alternative rate. As far as what the shift away from LIBOR means for markets, Hammack says, "First and foremost I think the impact is going to be hopefully an improvement in safety and soundness."

This podcast was recorded on September 27, 2018.

The information contained in this recording was obtained from publicly available sources and has not been independently verified by Goldman Sachs. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, as to the accuracy or completeness of the information contained in this recording and any liability as a result of this recording is expressly disclaimed. The recording should not be relied upon to evaluate any potential transaction. Goldman Sachs is not giving investment advice by means of this recording, and this recording does not establish a client relationship with Goldman Sachs.

Copyright 2018 Goldman Sachs & Co. LLC. All rights reserved.

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This as exchanges Goldman Sachs will discuss developments, curly shaping markets industries in the global economy, objects, seaward, global, had of corporate communications here the firm to enable their talk about labour or the London interbank offered rate sounds like a niece finance term, but it actually affects more people might think we spend a lot of time in this pod gas talking about crypto currency. This is a market that much bigger scale and has a lot more
vacations for people in their daily lives. To talk through what library is, what went wrong with lie bore and now the industry's moving away from this rate were joined by Jason, granite head of the firms. Why bore transition efforts and Beth Hammock, whose our global treasure for the firm Jason Beth welcome to the proverb shake? That's, let's start with you. What is lie bore and why does it matter? Sharp libraries are eight, that's been around for a very long time, estimated at about a hundred and fifty years that has actually been in existence, but it really came to drive the markets about thirty forty years ago, in the eighties, when derivatives became very popular people, we're looking for. Rate that symbolise the front. Under the market there was a floating rate they could use and, as you talked about, it became heavily used in derivatives as well as mortgages, consumer loans and other products. It's a global rate in that it is too for specific currency. So there's U S: dollar live or theirs sterling Labourer, there's again lie where it exists for a number of different currencies, but it's meant to represent where banks could finance themselves in the front end of the market
It also exists in both overnight out to one year terms, so it's a pretty broad spectrum over time, so essentially the cost of money to banks. It's exactly right. It's where banks can borrow from one another in the marketplace which determines in turn what they can charge for money. Exactly Jason Weber was in the headlines alot several years, Saint Louis yeah and those this whole issue around manipulation, explain to us what went wrong and how the industry regulars responded at scandal. So there's a real big structural shift in the market over time, as Beth indicated there. All these tenors and inter banks had a lot of activity lending to each other, but that is we went to the crisis and as key came a bigger and bigger part of policy. The market of Inter Bank Lending, in very short tenors, actually start to dissipate and become quite scarce and so that the volume of activity went down significantly at the same time, the derivatives markets
other markets that you reference the mortgage markets and see all markets experienced tremendous growth over the last ten twenty years. You had this balance where ton in tonnes or in this case hundreds of trillions of assets or referencing. Why bore rate in resetting off it, where the activity was the underlying that would establish the rate actually went down. So to put it in context for three months I bore which is kind of the most ubiquitous. We have something two hundred trillion of global assets that reset off that rate, whereas now we're down to about three hundred to maybe five hundred million of actual daily activity and three month bank to bank loans. She have to four trillion of assets resetting off three hundred million of activity feels like the world has shut it very, very meaningfully. How're we transitioning, and why are we now? Transition life in this rate mean you explained the mismatch between the way in which the prices set in its importance. So, let's go
but the transition now Jason you're. So the regulators came up with a few different things. One is. They came up with principles about the best ways to have benchmarks is robust, underlying activity and then hear specific, we in the? U S the FED, convened a group called the alternative rates, reference committee or the are. Let us call the Argo just copy. The art someone who knows so what it was as it was fifteen of the major swaps dealers in the derivatives markets. Could the derivatives were the bulk of those transactions? Are prince something in the neighbourhood of two hundred trillion in the? U S? Call ninety five percent exposure can be in the derivatives markets. An arc was really charged with a few things. One idea find an alternative to lie bore to what the viable plan, games for rolling that alternative out and then three getting the world comfortable with the language to transition, so Doc
patient language, about going from old to new in the event that there was a cessation or end of the publication of. Why bore which, quite frankly seems like a more more real event, given the the that regulators have made, and specifically the regulator. I bore, which is the FDA in London, Jason The criticisms of labor was that it was set by the British Banking Association and not by real market without a legitimate criticism. Oh you know it's. Actually. An interesting, because the way lie. Bores calculated is a group of panel banks would answer a question each morning. This ring between sixteen and twenty panel banks over time as banks have come and gone, there would answer the question of at what rate there lend money to one another, then originally the British Banking Association and later in and more currently the ice benchmark administration would take those different rates the outliers and publish the mean,
each day, just before noon in the UK, and that would be the library those calculations were done largely on export judgment. They were never really based on historically, never really based on true market transactions, and one of the things that very important here in the movement a lot of these new rates Development of alternative benchmarks is to migrate to re. That really have robust volumes in real terms. Actions under them as opposed to ones that are based on export judgment and just broad calculations that are done in small groups that what will the impact of this transition be firm markets for the industry and for people who have maybe a massive, sometimes the most massive debt they have is denominated in Lebanon or popular
First and foremost, I think the impact is gonna, be hopefully an improvement in safety and soundness. As Jason talked about, we have an enormous market, that's referencing, a very small market, and that puts instability and some potential risks in terms of how that underlying market could move, have unanticipated consequences for the rest, the marketplace. Earlier this year we saw live or widen pretty significantly relative to other reference rates, but again there was lot of fundamental activity that was driving it, and it's when these Korea is that the market, as it goes through that sad, it's gonna be a really painful transition to their because there are so many people, and so many products there are referencing this rate. It is such a foundational part of our markets and markets are really creatures of habit. People like to be engaged in involved and things that have a lot of liquidity that makes them feel like their transaction costs. Lower. The transparency is better, even if the underlying nuances about rate may not be as robust as they wanted to be. They still feel there's a lot of their safety in numbers, if you well so their addicted to what
been doing either ahead, does make a lot of economic sense, so Jason. What's the process for physically winding down libel or and moving on to new, then works and how long and costly might there be it's nothing short enormous for a lot of people, as Beth indicated its not just ubiquitous in markets, but his foundational for how a lot of other things are built on so We have. This alternative rates committee has identified a globally that the replacement rates around the world, where slowly, moving through understanding imitation understand amount of inventorying about sending trades, there's industry group that are born around the globe by all the central banks to identify all the different aspects of the It's all right now. I would say that we're like an inventorying phase of understanding everything is, and that will help define the path as we go forward now here at the end of September, we have three or four open council,
nations by various industry groups for the world comment on their views on what's been proposed, as language and alternatives for a lot of these places that that talked about where the rate is present and so now our inventorying and identifying This is to go to prepare for the change at the same time, We also seeing development in the new rights we have somewhere in the neighbourhood of ten billion of issuance. In some of these, new rates were seeing about one a week these days. We're seeing new futures contracts and swap market starts a pop up printing the new rate, so people are starting to ass the ropes and test the waters of some of these rates in places so that eventually people can get comfortable as liquidity, migrates, so easy for people to get comfortable is gonna, be a process, but other folks, listing this change who's, not on board with the transition to new rights. I don't know if it's that there, on board, but there's still a broad education phase,
going on clearly when the central bank's convene folks, they started with them banks now they ve expanded to major pensions, major users, the extra in June, the Cecy peas kind of the usual suspects are folks that would use these types of problem Serbia engaged in this at the highest level, but spends all the way down to the consumer. In many cases, you talk about credit cards or car loans, or people's mortgage their house etc. So it's gonna be a process to get from the latest outstanding impact. Down to all. Folks that are touching it right now, it's a meaningful move through the education process and for me I would actually say we're a lot further along that I would have said we would be six months ago when we started really in earnest. Looking at this as an organization at the beginning of this year, we probably projected where we are now to be where we would be in the first quarter of next year and so we're seeing development market lots of education.
This fluency and a lot more places to talk about it than we were expecting so actually, quite frankly, it has A lot of momentum and people are really talking about it what are some similarities between lie: Borg, the traditional metric and the alternative briskly rates, including the? U S, replacement and from the other rates that are used around. So, as we talked about before, one of the core issues of labour is that it is a credit, sensitive rate. A lot of new rates that we're talking about and looking at the marketplace, our risk free rates that don't have that same level of credit sensitive So in the? U S: the secured overnight financing rate sulphur is what is being called. That's the likely successor for labour and so its similar and that it's a short and rate it'll float overtime, but it's in overnight rate labour as and was really the most likely that the three month point and was a prospective three month. Credit sensitive rate suffers but different, in that it's a secured rather unsecured risk free. It's based on treasury collateral.
And it's an overnight rate and so they're going to be some hiccups and some nuances as we move through and look at those changes as we move forward, where the other key different as one of the primary reasons why sulphur respect as a replacement rate for the? U S? Is it it's an eight hundred billion dollars market in terms of transactions every day. So again, let's go My bore the overnight transaction volume. That's going through about three hundred million sulphur hesitate, eight hundred billion, but contracts linked or in the hundreds of trillions. So each of these is growing in size, but do not give us a bit more liquidity to look at, and you took my credit risk and lie bore. So I was you during the crisis was why Borst, today have to those credit risks that emerged between banks. It was very sensitive, and so what you saw was the other way had been really popular as the FED federal funds rate, which is the target rate used by the Federal Reserve when they get setting monetary policy and when they try to control rates at the front under the market. But through the crisis you actually saw that FED funds lie where basis
which had traded, pretty consistently in the low double digit caught ten fifteen twenty basis points move out to north of a hundred basis points through two thousand eight. So there was real credit sensitivity now that was a benefit to banks for some perspective because they had loans that they'd made that we're linked to live or, and so as their funding costs widened as it became more for them to raise money? They were getting that on the assets they had on the other side match they had a match. Sulphur won't have that the other reference rates globally, just can talk about. Some of them are also more geared towards the risk free government type rates rather than this credit sensory. So that's an issue that banks are gonna have to work through. So Jake was interesting. Is people always viewed libraries equally as the risk free rein, and then the crisis have and and exhibited a lot of risk as it widened blew out relative to other benchmark rates is Beth just indicated, and so part of what happened is that was an eye opening experience. So I think one of the good outcomes of what's happened here is the central banks and the. History have put forward what I would argue are true or much much closer to true
for your near risk free rates. We were talking about people being on board now. This is community of folks who wants something with the credit sensitivity and that's where the Pegana round hole for the market is right. Now we have identified fair good, robust heavy volumes your risk for your risk free rates. Yet the mark. Still want some type of credit experience because a lot of people have lived to the crisis and they want that match that Beth just indicated in. So that's one of the real risk matches, trying to figure out exactly how to calibrate for that in this transition phase that one of the bigger reconciliations that's taken place. Just add that I think, partly because of some of the regulatory changes that have happened. The fact that the FED has pushed banks to find themselves for longer to not use, the short dated markets- you just won't- have the same volume going through its a fundamental market structure change you won't have same volume in a credit part of the market, the EAST,
and TAT may not be possible to find a credit, sensitive rate that we can in the near for the medium term, but imagine a notable difference, in labour and sulphur, which is their labors, unsecured sulphur secured? What does that really mean for the industry? I think it was secured verses secured. Frankly, it is less of a problem for the industry than those credit sense and not credit sensitive part of it secured verses. Secured, just means of theirs theoretically collateral behind at when we're talking about the secure, great we're talking about governments and Again, it is more of a risk free rate that you're looking at think it has more to do with that credit component. Then security, his unsecured in many of the other jurisdictions they ve chosen unsecured rates, but those unsecured it's our more at risk, free type level, so Sonia in the UK, where you think that is being more or less To government type collateral, rather than banks, sensitive collateral, Jason, Imagine that were little head, a pace that some unexpected talk about the pace of adoption of the risk we re on the globe.
Stage and mortar some of the barriers to implementation, what a regulator trying to do to help it is different speeds, indifferent, says, which is also one of the things that were all reconciling so here in the U S we ve identified, the rate are starting to see. Tat and actions in the rate there's future contracts with starting to have some liquidity and activity, at least in the first twelve to eighteen months. Part of the mark are starting to see. Issuers come to market. As I indicated, we ve seen around the first ten billion, specifically in the EU Stalin market referencing sulphur. So we have the rate we have contracts. We have things trading tonight, let's hop over the pond the Sonia market. That's the rate that Beth talked about as the replacement rate in the UK. They prefer. We have one of the more robust markets of these rates. The Sonya market is pretty well established. Over a much longer part of the curve than the. U S does already
Some volume of activity going, there is obviously transition that needs to happen, but at least is a little bit more depth of the market. Then we go to Europe and the part of the world that is on the thinnest part of the ice they just last week announced their replacement rate as the European short term rate The name here has couldn't be better than the others outside so far, so but the one thing, it is there not expecting to publish it until next fall, and so, whereas we already have bus markets in the other rates the Europeans aren't even in a place. Their publishing their replacement rate more so they have specific legislative benchmark regime in Europe, that from January two thousand and twenty, which is only fifteen months away there workers, rights actually don't even comply, so they need a new rate and they need to get it up and going quickly and it can be they tight window and then
Switzerland, they ve identified their rate obviously a smaller market relative to the markets that we're talking about. But this was national bank, is moving forward in their activity there and then going out Forest Japan has identified rate. There's a lot of consolidation. That's gonna happen their market there's three or four rates that currently operating Japan folks are gonna migrate towards the one that's been identified and supported by the industry in the Bank of Japan there. Obviously this different challenges in Japan, given the nature of monetary policy in some things that have gone on there, but that we stay identified a rate and starting to move. If it is the time to point out that regulators have two choices here, they can apply the carrot approach of the stick approach. And in many central bank discussion, in industry discussions, people been talked about the carrot approach. Should we allow favourable netting treatment for the new transactions or make it very friendly for this new transactions to be born into the market, but the first big move came in
UK and they sent a deer ceo letter out to all banks and insurance come these mandating aboard approved transition plan before Christmas of this year, so tight turn around and very strong language to making sure people are prepared. London was willing to move beyond the London rate that they have. Quite frankly- and you know I think part of it is their market- was a little bit more developed, as I indicated that Sonya. But if you think about the entities that there too can't you they're, they're, very heavily involved in: U S tower transactions very heavily involved in euro transactions, etc, and so this gonna be a very telling time from now until the end of the year as people prepare for the european regulators and then it will be interesting to see kind of momentum that gets for more issuance more value, more activity, more movement to some of the new rates given regulators are clearly very focused on it. With the UK regulators leading the charge so Jason, what else can we expect from the transition this year,
I mean you covered a lot of the different geographies, but what are the big things? You're looking for in the market for us were very much following the activity in the market so for future which a CMU has rolled out? Has someone the neighbour of thirty thousand outstanding contract and sulphur and sulphur futures we're looking for that number two. Oh it's. Some continued, very substantial exponential parabolic pace to see if there's growth, that the market is real underlying it. So we're waiting for fast, be the accounting Standards Board to release their guidance on how they're gonna hit Will the new rates so far etc to make sure that their appropriate for educating treatment, which very important to many of our corporate clients and others who use a lot of these rates to hedge different types of risks in the market, and then I just mentioned, what's happening with the UK, Later, there's going to be a roll out of significant plans there, which should spur activity and issuance and other things, and so those are too
landmarks that were watching to see if this meaningful growth in these new rates and they get their liquidity that can support the move that is needed with the hundreds of trillions that we indicated, but I'd others, some smaller scale, things that we need to happen as well, some of which are just system belts. We have a lot of trading systems, both internally market platforms, that dont know how to handle or process trades that have these daily resets. So some about working, done. Risk models across the street are highly based off of library. People going to have to start migrating away from as well so Jason about a lot of a really big picture, things that we're looking for from a headline burst of a regulatory perspective, but there's a grandmother work. That's going to be done firm by firm to get this implemented So we recently put one person in charge of our effort and the transition to his own life. Why did we do that? Why that's important have one person in charge? We started out the price at the beginning of the year, looking at their looking forward being involved in a lot of these processes that Jason talked about and thinking that we could pull this other through our usual coordinated, Collaborative Goldman Sachs style, but as we started to dig into it and really
through we just found. This is a much much bigger scale problem. Then we ve seen and we really need the accountability and coordination to make sure that we have one person driving this effort for the firm for our clients to help be a port of call for people have questions who have concerns to make sure that we ve got consistent message. Inconsistent answer There are questions that are coming from whether its clients are regulators with two three pages lists of differ knit so, they want to know what's going on in cyberspace and those come in through our classic cells and trading organ nation they'll come in through our investment management of. But if one person tries answer that on their own they're, not gonna, have the full resource in the full scope or breadth of knowledge that we're point together, and so getting Jason someone who has then in these markets, whose traded in and around the front end before has passion for thus understands the implications it's gonna have
on the market on our clients on our business, as we thought was really critical to make sure that we can do this in a world class way. Jason back mentioned that you recently joined corporate treasury from juice, Amor, Gormans asset management business. Then you have a background and asset management and actually trading these instruments. Now you leading global firm, wide effort. What is common, doing to prepare for this transition and what kinds of questions are clients ask we're doing a fee different things. We just talked about a moment ago. The big industry initiatives, market developments, developments of new products, etc, so were clearly have a big focus on making sure that were purchased dating in those conversations leading from the front with respected, developing them, making sure that they fit in the spectrum of all the different financial instruments and things that are into our clients. Then there's also the bottoms up stuff that Beth talked about a moment ago. They want system readiness, model calculations, making sure that we
full understanding of how the blocks connect together and making sure that, of our models and technology cetera can accommodate all the new rates in my great over and then on the other side, were engaging with our clients, whether it be through our private wealth management area, whether it be through our securities division cells and trading group, whether it be through our investment Enfranchise, making sure that were really out there talking and engaging with clients, as they have done. Levels of understanding education. Exposures to these different rates and really putting them and walking with them side by side as they go through. What can be, quite frankly, is
Harry transition for some of them, given the pervasiveness that this rate has across all different types of markets and s classes, so bad, it seems improbable, but you recently celebrated you're twenty fifth year at the firm yesterday when I was twelve of yellow, recently new job, a big job as the companies treasure talk a little bit about what that means is that twenty five years you spent here and some of the surprises, how your career has evolved, the fur it's been an exciting year, both in terms of my transition to Treasury and in terms of getting the twenty five year, milestone, something that obviously we pride pretty Nebulae Goldman Sachs, our quarter century club, and so I was excited to have that milestone and to be a part of it. But I've seen a lot when transactions at the firm started and ninety three and at that time, It was the desk at an interview with him before I moved into our derivatives, businesses and I've, been a lot of senior people, it I've seen grown up, and so him now transitioning out of the firms David, come into a leadership role- is a pretty exciting next transition. One of the things that I will say, that's been the constant throughout my twenty five years has been that chain.
And that collegiality, in that continuing terrain, and develop talent overtime. It's hard to surprise me things, but the team was actually able to surprising with the twenty five year celebration on the DAS, but like all things that Goldman Sachs you're right back to work and lots of new challenges ahead to get through our right Beth Andriessen thanks for drawing me today. Thank you. They shake includes this episode of exchange? The common sacks thanks for listening- and I hope you join us again next time the spot cast was recorded on September, twenty seventh, two thousand eight teen, the information contained in this recording was obtained from publicly available sources and has not been independently verified by Goldman Sachs. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty ass
the accuracy or completeness of the information contained in this recording and any liability as a result of this recording is expressly disclaimed. This recording should not be relied upon to evaluate any potential transaction. Goldman Sachs is not giving investment advice by means of this recording, and this recording does not establish a client relationship with Goldman Sachs.
Transcript generated on 2021-09-20.