November 2, 2017 / 6:04 PM / 20 days ago

REFILE-Bond buyers balk at banks setting rates

(Refiles for wider coding)

By Eleanor Duncan

NEW YORK, Nov 2 (IFR) - Major bond investors told the Federal Reserve this week that they do not want banks to have the power to decide the reference rate on their own deals once Libor is phased out.

Both the buyside and sellside have been puzzling over what will be the benchmark when the London Interbank Offered Rate, which has been dogged by scandals, is taken out of use by 2021.

But several recent bond deals have included language that gives the bond’s banking underwriters the option to name themselves or others as the so-called calculation agent.

And in a letter to the Fed, The Credit Roundtable - a group of major investors with more than US$4trn of fixed-income assets under management - said that should not be the case.

The agent must be an independent investment bank or commercial bank other than an affiliate “to avoid potential conflicts of interest and improve transparency”, it said.

The group said it should choose the agent, though it was not clear if that meant a separate agent for every deal or one selected to be the permanent decision-maker for all bonds.

The agent should not be required or permitted to exercise discretion with selecting a new base rate, it said.

LIBOR LIMBO

Libor is currently referenced in roughly US$300trn of contracts globally, according to the Federal Reserve, including floating-rate bonds, derivatives and syndicated loans.

So even if investors accept language in new bonds that allows underwriting banks to call the shots, holders of bonds that mature after 2021 could still find themselves in limbo.

One potential fix would be for Congress to make a statutory change, though the Roundtable rejected this as an option.

“We think is unlikely and would have negative repercussions for investors, issuers and the markets in general,” it said in the letter.

It suggested issuers could exchange bonds issued under Libor for new securities that would reference a different base rate, though it acknowledged difficulties with that as well.

“Exchange mechanics are costly, complicated and heavily regulated,” it said.

“Also, there is a very low likelihood that all investors will participate, which will create illiquid legacy series that will trade cheap to an issuer’s credit curve.”

QUESTION AND ANSWER

The group’s letter was in response to the Fed’s call for public comment on its proposals to use three new reference rates as alternatives to Libor.

All are based on repurchase agreements backed by US Treasuries - and the Roundtable found fault with each of them.

It said that a borrowing rate secured by risk-free collateral - such as Treasuries - is too rigid, and could be influenced by monetary policy or sovereign credit deterioration.

But of the three, the Roundtable prefers the Secured Overnight Funding Rate - which does not currently exist and is not planned to be released until the middle of next year.

The Roundtable said that SOFR represents the broadest pool of repo transactions and would be more applicable to a wide range of market participants in a variety of funding markets.

The Fed’s comment period on its proposals expired on October 30. (Reporting by Eleanor Duncan; Editing by Shankar Ramakrishnan and Marc Carnegie)

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