LIBOR permeates nearly every aspect of financial markets with its link to approximately $370 trillion of financial products across the globe, including nearly $200 trillion in USD LIBOR. Given LIBOR’s enormous scope, a carefully planned transition to an alternative index is essential to avoid potential significant market disruptions that could affect every financial market participant.
PGIM Fixed Income’s latest whitepaper seeks to address the progress of the transition, critical future milestones, and concerns regarding the sufficiency of SOFR as an adequate LIBOR replacement.
LIBOR’S Market Presence
The main categories of contracts indexed to IBORs include OTC derivatives and ETDs, syndicated loans, securitized products, business loans, retail loans, floating rate bonds, and deposits.
Source: IBOR Global Benchmark Survey 2018 Transition Roadmap, ISDA February 2018. TIBOR is based on interbank lending amongst Japanese banks; ETDs = exchange-traded derivatives.
Read the full whitepaper, The Libor Transition , which is available for financial professionals.
LIBOR reflects the average cost of borrowing for approximately twenty AA- and A-rated banks across seven different maturities and five currencies, and is based on a combination of observed transactions and estimates/judgement. SOFR will reflect the volume-weighted median of the previous day’s Treasury repo transactions across three categories, which excludes all trades longer than overnight.
Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Commercial mortgage-backed securities (CMBS) are a type of mortgage-backed security backed by commercial mortgages rather than residential mortgages. They are composed of a variety of loans, each of which represents different property sizes and locations. These loans are pooled and are broken into tranches of risk that are sold to investors. High yield bonds, known as junk bonds, are subject to a high level of credit and market risk. International bonds are bonds issued by foreign corporations or foreign government agencies. Emerging market bonds are local currency bonds issued by emerging market governments. Emerging market countries may have unstable governments and/or economies that are subject to sudden changes. These changes may be magnified by the countries’ emergent financial markets, resulting in significant volatility to investments in these countries. Investment-grade corporate bonds are bonds with a credit rating of AAA to BBB as rated by Standard & Poor’s, or Aaa to Baa as rated by Moody’s. Mortgages refer to mortgage-backed securities (MBS), which are composed of a variety of residential mortgage loans, each of which represents different property sizes and locations. These loans are pooled and are broken into tranches of risk that are sold to investors. Collateralized loan obligations (CLOs) are securities backed by a pool of debt, often low-rated corporate loans. Municipal bonds are tax-exempt bonds with a maturity of at least one year, including state and local general obligation, revenue, insured, and pre-refunded bonds. Unlike other investment vehicles, U.S. government securities and U.S. Treasury bills are backed by the full faith and credit of the U.S. government, are less volatile than equity investments, and provide a guaranteed return of principal at maturity. Asset allocation and diversification do not assure a profit or protect against loss in declining markets. Past performance is no guarantee of future results.
The views expressed herein are those of PGIM Fixed Income investment professionals at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Neither Prudential Financial, its affiliates, nor their licensed sales professionals render tax or legal advice. Clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy. This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation about managing or investing your retirement savings. Clients seeking information regarding their particular investment needs should contact a financial professional. PGIM Fixed Income is a unit of PGIM, Inc. (PGIM), a registered investment advisor. PGIM is a Prudential Financial company. © 2019 Prudential Financial, Inc. and its related entities. PGIM and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.
For Compliance Use Only: 1019118-00001-00 Ed. 03/2019