"One Rate to Rule Them All:” KKR’s Tal Reback on LIBOR Transition

What impact have the March 2021 ICE Benchmark Administration (IBA) announcements had on LIBOR transition efforts? In this episode, Dechert’s Matthew Hays and KKR’s Tal Reback discuss where preparations for the transition stand today as well as the impact of a multi-rate environment, whether the market should wait for term SOFR and more.

Transcript

Copy

Intro  0:05 
Welcome to Dechert's LIBORcast, where industry leaders come to talk LIBOR transition.

Matt Hays  0:12 
Hello, and welcome to this edition of the Dechert LIBORcast. I'm Matt Hayes, your host. I'm a partner in our global finance group and chair of the Dechert LIBOR Task Force. Today I'm pleased to be joined by our special guest Tal Reback from KKR. She's leading KKR's LIBOR transition efforts and is also a member of the AARC. Welcome to the program.

Tal Reback  0:29 
Thanks, Matt. Thanks so much for having me today.

Matt Hays  0:33 
Well, we're in the midst of an interesting time with notices flying and alerts going off from pretty much everybody I'd say. Does this increase on the scale of Y2K to the end of the world what the LIBOR transition is? Is it sort of the time for these types of notices and do you expect it to get more chaotic or or less?

Tal Reback  0:53 
It's a great question. It is an exciting time. I think the fact that we had, you know, a benchmark transition event last Friday is a big deal. It's a huge data point for the market. It provides certainty and clarity with respect to dates, but also, obviously it struck a spread adjustment, everything people were waiting for. And you know, I'll be honest, I don't love the Y2K. I think if anything, LIBOR and the LIBOR transition, it would be great if it ended up being like Y2K, because that means it'd be a non-event, right? I think that would make it super successful. And it means that everyone did their job and was super prepared and proactive. And not to say that that's not going to happen, but I think Y2K as an analogy sometimes kind of understates the complexity and the nuance and the level of intricacies that really exists here. And I know, I know, you know all about that, too. And I'm excited to talk about it today. But that's why sometimes I just don't love when people throw out that statement.

Matt Hays  1:54 
Maybe they throw it out in the hope that everything goes well.

Tal Reback  1:57 
Exactly. I think that's the right spin.

Matt Hays  2:00 
Okay. So obviously, we have the benchmark transition event now, do you think that means that everyone can kind of prepare now and that LIBOR will end as on the dates, you know, set forth? Or do you think that this is just another in the line of, you know, events that sort of may indicate the timeline?

Tal Reback  2:20 
I think the timeline is pretty set. At this point, I don't think we're gonna see another extension, or head fake, if you want to call it. I do think this enables market participants across the board to really move forward with execution and planning. And I think what the BTE really did was shift the transition from being something more theoretical or conceptual in sort of people's minds to really defined, and so although with U.S. dollar going out till June 30 2023, I think there's clarity, and I think you need to be prepared to live in a non-LIBOR world by year-end, which, in my mind, net-net is kind of the same place where we were pre-extension, in terms of being prepared, understanding your fallbacks, operationalizing the change, thinking about asset liability management. There's just a ton of stuff to do. And I think the market knows that now. And now we can kind of really stomp forward.

Matt Hays  3:18 
You mentioned the fixing of the spread adjustment, and obviously we have the numbers now, you know, through ISDA. Do you have any concerns that that's being fixed now and not, you know, closer to the end?

Tal Reback  3:30 
You know, I've spent a lot of time thinking about it. And I think there's two ways probably to look at it. Yes, it is early, because we still have quite a bit of time before the publication of LIBOR will cease. But I think, well, it was really important to fix it now to really double down that a) the transition is happening, and to give people pricing context to understand converted facilities. And quite honestly, you know, yes, I think when you think about it from a lender's perspective, being two years out before cessation, what does that really mean? It's more arbitrary. It's a point in time. But with that being said, I think if the loan market starts to shift, and you see some refinancing activity into SOFR, you can understand now like not to be corny, but it's kind of like you're benchmarking your pricing. So you understand like, where the line in the sand is, and you can really think about the go-forward. So while it's not, maybe, call it perfect, given we've had some changes in the overall timeline, our bifurcation call it between currencies, I do think it was probably the right move to make.

Matt Hays  4:32 
Okay, do you get the sense that this will start leading to more SOFR loan volume? Because we now know what the fallbacks will be and that issuing and SOFR is the better option at this point than LIBOR?

Tal Reback  4:47 
Yeah, I'm hopeful that we see SOFR activity pick up in the back half of this year. I do think the loan market probably has more context that it needs and maybe some more inputs to understand what this transition really means for that specific market. I do, you know, just from conversations I've had, like, across the street with borrowers, I think there's a better understanding of how this all works. So I would say that the loan market, if I had to guess, is probably going to shift. You know, Matt, it's interesting, we saw SR 21-7 come out earlier this week, you know, across the banks, and I do think you know, there's a big elephant in the room, it's to talk about the regulatory aspect of this. And so, yes, it is incumbent on market participants to do their job and to lean in and be proactive. But I also think, you know, there's an element of this where it's not going to be a choice for a very long time. And so as banks start to shift and be prepared to live in a non-LIBOR world, and maybe we see issuance kind of amortize down, to use another dorky pun, I think the low market is going to have to play ball and I think they're prepared to do so.

Matt Hays  5:59 
Okay, what concerns you about the the transition process from here to the end? Do you think the market larger is going to be ready? Or do you have some concerns about the next steps?

Tal Reback  6:10 
I think there's a lot of work to do, I still think there's a lot of work to do. You know, if we all do our part now going forward and are diligent about how we paper deals, we're thinking about how this change affects organizations, borrowers start to understand what it means for them should-be lenders, and we have those dialogues. Now, I do think we can be in a position where we're ensuring a smooth transition, but that assumes everyone is doing their part. So I think that's the one big thing that I think, you know, the BTE really kind of gave us last week, it confirms this is happening, it confirms we're game on. And now everyone has to kind of do their job. So if we go back to Y2K, you know, maybe thinking back to either before the ball dropped that night, making sure systems were updated, and like, you know, everything was being connected appropriately - downstream impacts, looking at your portfolios, doing that kind of legwork now, I think is really a good decision probably to make. So you kind of have a non-event in my mind. But yes, I do agree with you, the market probably needs to do some more work. And there's a lot of what to chop still.

Matt Hays  7:21 
Do you think maybe with the timing of the transition, and you know, maybe continuing the Y2K analogy of does it all need to happen at the same time on the same day for the market to largely shift or, you know, can it be sort of a successive series of transitions? And if it's successive, so who's the first mover?

Tal Reback  7:40 
Totally. No, I think it's probably successive. I think that's where this probably differs from the Y2K. I think we're playing with that thing now. So I'll keep running with it. Um, but yeah, I think, you know, we're not trying to deal with 12/31/2021, the plug is being pulled out of the wall, I think the tools are being put in place now to understand how to have that successful, but like, successive move away from LIBOR to kind of gradually do what you need to do across your existing book, and then thinking on the go-forward for the front book activity. And that's what, you know, given where derivatives, how they're being constructed across the transition, and cash products, I think that's the way it has to happen, quite honestly, because it's a little bit of an iterative process. And we can see that just from how the ARRC has evolved over the last couple of years. And the guidance and the best practices that have been put out that this is not straightforward. So I wouldn't expect it to be like, you know, one bold statement, and we're done. So I think now that we've had some more clarity, we kind of know what we're dealing with, we have the timeline defined, you'll start to see probably in the next couple of quarters called second and third quarter some more of that successive activity.

Matt Hays  8:53 
So you've mentioned a little bit about operational challenges. What do you think's the most significant going forward? Is it you know, data analysis? What work needs to be done there?

Tal Reback  9:03 
Yeah, I think there's a lot. You know, devil's in the details here with the operational downstream impact. Well, first, we can maybe spend a second on just data and systems, you know, we're moving to a rate that's compounded in arrears. Even if you use daily simple SOFR. It's a little different. It's very different structurally than what LIBOR is today. And just think about accounting systems being dynamic books and records cash received versus cash owed. Any type of trading activity, I think, especially in the loan market, you know, the loan market's opaque, it's not like the floating rate note market or the bond market. There's a reason it's T+7 at the minimum, you know, that's, that's just how it works. And so I think that's complexity that we're going to work through, quite honestly as an industry. And I think there's been a ton of planning from the LSTM, the ARRC on that and putting all the tools in place and having really robust industry discussions, but that's something that I think about. Think about how that, you know, data flows through just to like position level reporting, I think about how you think about your future cash flow projections, there's a lot to do there. And then, you know, you also have to keep the trains running. So it's kind of like building for the feature where the features a little bit different structurally, then what we've been used to, but also ensuring you can run in parallel and keep the business moving. And I think that's applicable for asset managers, for borrowers, for lenders, it's across the board. Okay.

Matt Hays  10:31 
So with the SOFR, you talk a little bit about the differences. Do you think any of those differences will make it too hard to use SOFR going forward? Or do you think all products can transition to SOFR without a problem, thinking about, you know, securitizations and some other products that you know, have sort of a lag, or have, you know, different accrual methods for the borrower?

Tal Reback  10:50 
Totally. It's complicated, I think, probably yes, is the answer. And that there's, that's why there's been so much work over so many years done to support like the transition over to SOFR, but it doesn't come without, you know, a lot of trial and error. And I think a lot of planning and modeling up front, securitizations is a really good point. And even CLOs is a really good point on just thinking about how those vehicles work today, and some of the complexity inherently we're going to run into with SOFR as a daily rate. You know, Matt, it might be worth spending some time thinking about, like, if we get a term SOFR, what does that mean? And you know, being early, I want to say we're not early days in the transition, but we're early days into the market kind of ingesting and effectuating the transition. So we've been now working on it for many, many years, it's been a very thoughtful process. There's been a lot of people involved. But now it's kind of a true test. And so I think if we look to the UK with with SONIA kind of having an earlier timeline, from a new issue perspective, really kind of starting to see how do these changes permeate through the market? What are we going to learn from new issue? And SONIA, what are we going to learn in the next, call it nine months, of this year as we prepare for LIBOR to go away? And how do we shift and pivot to like accurately make sure market participants know how to ingest the new rate. And securitizations is going to be one. I think that's something where there's a huge reliance on docs there. And really, that's not straightforward, as you know, because there's a lot of dispersion in the language. But that's where I think we need some more industry standards, we're going to have to really work together across sign get everyone on the same page in order for it to be successful.

Matt Hays  12:30 
Yeah, you've mentioned term SOFR, I know that the market has largely waiting for that, because it has a lot of the same characteristics as LIBOR and the architecture within the documentation and systems can you know, if you take the term rate and put it where LIBOR was, you know, it largely works. Do you think that will happen soon? And should market participants be preparing for a world without term SOFR?

Tal Reback  12:54 
Yeah, I think market participants shouldn't wait for time in order to transition because I don't know that we're going to get it in time. But I do think we'll probably get it. So that's maybe a long-winded way of saying the term SOFR, something that everyone has expressed a lot of interest in specifically, also the loan market. I do think you know, there's a number of people working on term structure right now. There's also a lot of principles and back testing and things that need to happen in order to bring it firmly to market. Especially with a new rate, people forget like SOFR is kind of new. It's only been around for a few years. But with that being said, you know, if we look at the 6/30/2021 dates in the best practices, do we get term before then? I don't know. It's probably unlikely. But do we get term by end of this year, early next year, I would say there's more of a possibility for that. My biggest message would be people shouldn't wait for term before transitioning off of LIBOR or making their plans. They should run in parallel  and be prepared that you know when term comes, cherry on top, but for now to figure out how to deal with a daily overnight rate as well.

Matt Hays  14:01 
Do you think there may be a second transition that if you, you know, build a framework to take advantage of the arrears methodology that if term becomes available, you want to switch to that, or do you think that work will be have been done to build the interference methodology and you'll just want to stick to that?

Tal Reback  14:16 
You know, it's funny that you mentioned this because I've had this discussion with myself as I've thought about the transition. And I don't know that I know the answer 100%. If you ask me for my personal opinion, I would say if you're already on compounding in arrears, and like me give a mechanism in your document to switch to term as soon as it becomes available, and it's automatic. Maybe that makes sense. But to go through another kind of amendment or procedural process to effectuate term, I don't know that there's gonna be a ton of appetite for that. I just think there's a lot of work that needs to be done. But I do think market participants are very mindful of term, like if you look at the waterfall in hardwire docs, day term is first, and you know, we've seen a lot of mechanisms where there's a, you know, climbing up the waterfall or automatic flip to term when it happens. So I think I think market participants are mindful that the timing might not be 100% aligned. I don't think anybody wants to go through two tsunami waves of amendments in the loan market. But I do think term is something beneficial to many. And look if we get straight, so for issuance, or we get, you know, refis, directly into SOFR, SONIA, etc. And we see the market shifting that way that will be, you know, a very interesting data point.

Matt Hays  15:30 
So, do you think that we'll have an alternative credit-sensitive rate developed? You know, will that gain traction? Is there work being done there?

Tal Reback  15:40 
Yeah, I think we're starting to see, we're already seeing a little bit of traction there. You know, Bloomberg has something that came out, the ticker's BSBY. Obviously, the Fed has had credit sensitive group, kind of miniseries with a smaller group of market participants to, to vet the issue and talk about it. I do believe we could potentially see a multi-rate environment, you know, that's not off the table. SOFR is intrinsically very different than LIBOR, you know, there is no "it's a risk-free rate." That's a big difference. And, you know, I think this is what makes markets, right? You know, they're kind of free to kind of do what they want. And we'll see if they converge, or if one rate wins over the other, I like to say, you know, back to my Lord of the Rings "one rate to rule them all." So we'll see if that rings true. But that's, you know, Matt, I think it's a really good point, you know, lenders have been vocal about what a risk-free rate may look like in terms of market volatility and the reflection of their marginal costs of funds. You know, these are important areas of the market that can't be ignored. And I do think we're starting to see more momentum there.

Matt Hays  16:51 
One thing that we've seen in the market having been used a few times is the concept of the in arrears rate or SOFR average in arrears used for periods in advance. So effectively taking, you know, what's a term LIBOR rate and replacing it with an arrears? SOFR rate? Do you have any concerns about that methodology? Do you think it will continue to be used in the market? Or, you know, should the market largely transition to using an actual in arrears rate with an in arrears accrual methodology?

Tal Reback  17:19 
Yeah, I don't have concerns per se over it. I do know, there's certain pockets of the market using that methodology over others. You know, in my space, in the corporate side, I've really seen kind of daily simple and compounded in arrears used the most but yes, I do think the mortgage market, and certain securitizations have been leveraging the in-advance methodology. I don't know if I would say, concerned, I think, you know, anytime you have variability between methods, that's something to be mindful of. I do think that, you know, operationally for some of those products, I understand why it makes sense for them. And there's been a lot of work done to kind of just, that the basis risk issues, especially when we talk about, you know, any type of hedging that may, because we know, is this 100% compounded in arrears? So, you know, that's something that, look, it's not perfect, I think we all recognize being in the weeds on this subject, that it's, it is not straightforward, and there has to be some compromises. But I would say what comes to mind more than that, as a concern for me is, you know, if you have multiple rates, or you have assets switching over to LIBOR, then new assets referencing SOFR in a securitization or structured vehicle, that to me is something to think about that is a little bit more concerning than in advance versus in arrears per se.

Matt Hays  18:45 
And do you have any concerns with, you know, an organization as large as KKR, there's a lot to educate about. I mean, I'm sure some of the terms we've even been using in this discussion are terms that have a lot of nuance to them. And you, you know, kind of are someone who's been involved in this, you know, every day. How do you educate market participants, portfolio managers on what these nuances mean, and where they should have concerns and where there are risks?

Tal Reback  19:10 
It's a great question. I mean, people make fun of me all the time, because I'm talking in all of these acronyms and jargon. You know, the biggest piece of feedback I get is like, can you please simplify and speak English. And so having had that now, feedback for a number of months, I think the best way to educate is continue the dialogue, you have to make sure, I think organizations have to just continue to keep their stakeholders informed. I think something that we've really talked about has been like, education broadly across the firm by business unit. Also making sure senior management kind of understands what this all means. And as complicated as this is, if we dial it all back, we can put it in layman's terms. You know, something I like to say is, LIBOR is like salt. It's in everything. You're gonna find it everywhere, even though you don't think it's there. It's there. So then you you conceptualize it for people and they're like, Okay, I get that right. Like, you can't take salt out of the cooking, like it's already in there. So now what do we need to do? All right, let's talk about fallbacks. Let's talk about mechanisms. What's a fallback, right? It's a mechanic to convert. And so I think once you start layering on the concepts, it does start to click for people, I would say the biggest, you know, when I was first getting involved in this, which is now a couple years ago, is SOFR and the methodologies and just kind of the twists and turns across the evolution of how SOFR came to be is probably one of the more complex things because LIBOR is so universal at this point. And so really being able to differentiate and distinguish what the differences are, and then where the risks come with that, I think is probably the most important message. And so I would really encourage people talk about it, you know, continue to talk about it, you'll probably find yourself repeating, but that's okay. I think it takes time for these things to stick and find simple ways in like, small spurts to be like, Alright, for my loan portfolio managers, here's where I'm thinking the biggest risks are today. Okay, for all of my leverage facilities, here's what I'm seeing in the market for my portfolio companies. XYZ is what we're super concerned about. But here, let me, the punchline is: Different rate, has to get across all your systems, has potentially basis risk, has potential market economic risk, has potential legal risk. Now, how do you mitigate that? And I think when you boil it down, you can really deliver the message.

Matt Hays  21:32 
Great. What's your view on the proposed New York legislation? Do you think it will pass?

Tal Reback  21:37 
You know, I think the New York City Bar just came out with something last night that looked like it was supportive? Um, you know, from what I can see, it does look like it's gaining traction, and making its way through the governor's budget. I know New York State legislation has been something in the works for a while, you know, with the pandemic last year, there's a little bit of pause there. But it seems, it does seem from my my view, which is not in the front seat on this one, that it looks like it's heading in that direction.

Matt Hays  22:06 
So did you have a view on the federal legislation that's also percolating?

Tal Reback  22:10 
I think it's percolating. I mean, look, you know, federal, I think has always been something that many market participants have vocalized that is, could be very beneficial. You know, obviously, all these credit agreements, although the lion share are governed by New York law, like it doesn't account for everything. So I think the federal legislation is something that, you know, is that overarching kind of failsafe, if you will, and I also think it was drafted after New York State. So there was a different mindset, we had learned more and knew more. There's a lot happening in Washington, DC. I know it's on people's radar, I think with dollar LIBOR going out till '23, that probably gives us some more time to get it through. But yeah, I think that's something that's also super important.

Matt Hays  22:54 
Okay, do you think it solves the tough legacy problem? Or do you think we're still gonna have, you know, challenges with contracts that don't have fallback language, or, you know, basically use the last LIBOR or, you know, some kind of zombie LIBOR?

Tal Reback  23:10 
Yeah, it's, um, zombie LIBOR's a good point, because, you know, something that we saw in the FCA announcement was the contemplation of a synthetic LIBOR. For US dollar, I think, I think look at striving to solve the tough legacy. Tough legacy is defined very specifically, it's not exactly the same way it's defined in the UK, I don't know that we're going to sneak out without any issues whatsoever, I do think it probably helps kind of mitigate some of the big ones. And hopefully is, you know, put into place where it gives people a little bit of peace of mind or it spurs you know, for any type of litigious activity, it kind of helps in that arena. But I think zombie LIBOR, synthetic LIBOR, that's super complicated that comes to the US. That's not, Matt, that's something that like, I don't know, I don't know that that mechanic works here for us. Um, and so that would be one of my, my definitely a concern, hopefully a concern that we don't have to deal with. But yeah, I would say that not sure we can rely 100% on what's happening today to take care of that, if that comes to the US market.

Matt Hays  24:20 
What's your sense of engagement? We talked a little bit about the education piece, but are people broadly engaged in this and understanding, you know, you think kind of counterparties that you're seeing in the market, you know, appreciate what's going on and how to approach it? Are you finding that you're having to do a lot of education and trying to get people more engaged?

Tal Reback  24:41 
Yeah, I think that pre-BTE, engagement could have been higher. I think now that we've had a trigger event, I do see a noticeable difference. I would say if we take a pause and look back at last year, obviously there was a ton of things happening in the market, like crazier globally for everyone, all things aside. And so LIBOR transition was top of mind for those who are probably more in the trenches and in the weeds, and then took a little bit of a backseat, you had your November 30 announcement kind of come out where some people interpreted that as like a reprieve, although it's not. And now I would say 2021 has really started with a much more robust attention to the transition. I do see counterparties much more engaged, I do think LIBOR is now top of mind for many across the market. And they're asking the right questions. And then if we fast forward to this past week, I think the trigger event has really shown that now, if you weren't paying attention before, you're probably paying attention now. Because you want to understand what that really means for you. And so I do think we're trending in the right direction. But yeah, I would say, if I had to graph engagement, we're creeping up. We're trending, but we could still continue to increase.

Matt Hays  25:59 
Okay, well, the right direction, I suppose. Do you worry at all about reliance on fallbacks? And that, you know, part of that engagement is really understanding that, that not all fallbacks are the same. And that there there's a lot of nuances there to understand just in terms of timing and decision making. And, and, you know, what the timeline to effectuating a fallback is, and you think that's, that's got to being fixed? And we have more of a consistent approach now, or do you think you're still gonna see, you know, wide variety of fallback language?

Tal Reback  26:30 
We have seen a lot of variety in fallback language world and although it started to conform more to a hardwired approach, there's still variability, you know, with, and I know we're talking about the trigger event. So it's great timing that we're having this discussion today. But I think that trigger event actually enables you to streamline your fall back a little bit more, because prior to that you had a very long technical legal amendment. Although hardwired and prescriptive from a waterfall, and you kind of understood what your future reference rate would be. It was contemplating a lot of potential future actions. So I think to answer your first question, um, still variability with fallbacks. I do think there's probably over-reliance on fallbacks. And people need to remember that this is a mechanic, there's a shelf life to it. It's a mechanic, it's not forever, the shelf life, we know is probably for 2021. So I think that's takeaway number one is like, Alright, I'm using this solely to get from LIBOR to something else. Now that we have the benchmark transition event, you can now streamline that language further, to be more specific, that specificity allows you to have sleep at night insurance is kind of how I feel. So you can be rest assured that that document, it's in the color green category, and it's not hanging out over in red, like needs attention. But I also think that when the market starts to see new issuance SOFR, and we start to kind of really move off of LIBOR from, you know, a new product perspective, that's when you're not going to have fallbacks, right. That's just a new document that references a new rate that's completely different. So I think I think people have forgotten that fallbacks are not forever there. They are a legal mechanic to ensure that you know, what happens when LIBOR ends?

Matt Hays  28:23 
Right. Do you think now that we have the benchmark transition event that, you know, things like pre-cessation triggers? You know, they won't try to do that, you know, sometimes we now in the end, because we have a real timeline with real, you know, sort of what what we're relying on?

Tal Reback  28:38 
That's a good one. I mean, look, I wish I had a crystal ball for this whole thing. I don't think anything is off the table, I, I would imagine that we have what we need is probably my guess. But knowing how the LIBOR transition has evolved, you can never assume, right? I think you can never assume. It's really important to play out all types of derivations of a situation contingent upon what the investment is, and really understand where you're exposed versus not where your risks may be, and be prepared. And I think that, Matt, goes back to why there's been so much, you know, thought process and evolution from a legal side, like you've seen it, you know, on the front lines, like the language has really transformed stylistically from approach. And I think it's because you know, there's, this is like a nine-sided die. Like, there's just too many angles, and so you don't just get one roll. Right. So I think that's what, yes, I think we have a lot of the inputs. Yes, I think we can make a lot of decisions. I think people know what they need to do, but I don't think you can definitively ever say we're ruled out of any possibility until live or actually ceases.

Matt Hays  29:49 
Right. wait to see it happen, I guess. Thanks so much, Tal, for joining us. It was a great discussion night. I appreciate the insight. It's really helpful.

Tal Reback  29:58 
Yeah, thanks, Matt. for having me. I really enjoyed it.

Matt Hays  30:02  
Thank you to our audience. We hope you enjoyed listening. Please check out our LIBORcast channel to hear other insightful discussions with market and industry leaders, including regulators, trade associations, and market participants about the work ahead in the LIBOR transition process. Thanks for listening and have a great day.