Case Studies

Fermi Labs and Fieldfisher LLP were mandated by corporate services providers to project manage the transition program for 40 RMBS Transactions  

Context & Background 

Residential Mortgage-Backed Securities (“RMBS”) is a popular structure to ensure participation of investors, beyond the traditional banks, in the significant mortgage market in the United Kingdom. 

In simple terms, RMBS essentially creates a pool of individual mortgages issued by financial institutions and in turn, uses them as a collateral for the Notes issued to different types on investors such as the insurance firms. The Note investors therefore play an important role in the market by indirectly providing liquidity to the mortgage borrowers. 

All the cashflows (both principal repayments and interest) paid by the mortgage borrowers into the pool are then distributed to the Note investors.   

The underlying mortgages can either be issued on a fixed rate, basis or floating. However, a large number are floating i.e. linked to a floating rate benchmark. The most popular benchmark used historically has been the 3-month GBP Libor. In order to make sure that the cashflows received by the borrowers closely match the outflows paid to the investors, the Notes also carry floating coupons that are benchmarked to GBP Libor. 

The structure, from cashflow point of view works well, unless of course, there are delinquencies, defaults or prepayment of the mortgages. These risks, however, are well understood by the Investors. 

IBOR Discontinuance Introduces New Risks to Borrowers & Investors 

Upon the discontinuance of IBOR, the floating rate benchmark of GBP Libor will need to be switched to an Alternative Reference Rate (“ARR”). Given that proposed ARRs are economically different from GBP Libor, each individual mortgage will need to be re-priced by adding a spread (“Adjustment Spread”). This raises two potential issues from the borrowers’ perspective, that need to be addressed: 

1. While the borrowers fully understand Libor as a benchmark, the ARR, in most cases, is new to the borrowers. Therefore, every borrower will need to be educated on the new benchmark in terms of its construct and variance from Libor 
2. The borrowers must be explained the Adjustment Spread and calculation methodology. The borrowers will need to be comfortable that despite the increase in the spread being charges, they may not be economically worst off in the long term 

Furthermore, practical considerations on the underlying mortgage loans and investors’ preference could mean that different benchmarks are used for mortgages and the Notes. This may create cashflow risk to the investors to the extent that the two benchmarks diverge. This risk will need to be analysed and quantified and possibly hedged.  

The Issuers also need to follow a process to affect changes in the Benchmark 

The issuers will need to carefully craft a strategy to communicate the changes in the benchmark and also the spread to both the Noteholders and mortgage borrowers. The process has to be legally vetted in order to avoid potential litigations from the stakeholders. The FCA has also made sure that the financial institutions recognize that this is not an opportunity to make extra revenue at the expense of their clients. 

As a result of FLR’s ability to provide advanced analytics in the IBOR transition space, pricing capabilities and Fieldfisher’s legal expertise, ALP and Fieldfisher have been mandated by the client, managing and servicing RMBS to advise both borrowers and investors on the ensuing risks as a result of IBOR discontinuance. The mandate in respect is of 12 RMBSs, with average number of 2000 mortgages each and 4 tranches. The RMBS were structured by German and Swiss banks and managed by UK based servicers.