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The replacement LIBPR

 

2020-01-23

  
​Background
​Following the LIBOR-fixing scandal exposed in 2011, and the general decline in the importance of interbank lending in the financial markets, UK regulators have indicated that it wants to move the markets away from using LIBOR as a benchmark in favour of using risk-free rates (RFRs) which are less susceptible to manipulation.

In 2017, the Financial Conduct Authority (FCA) announced its intention to stop compelling banks to submit the rates required to calculate LIBOR. The FCA and other regulators have encouraged financial market participants to take steps to cease using LIBOR after the end of 2021. 

In light of this, it is important that our customers understand what the withdrawal of LIBOR entails and what actions they should be considering. This briefing is for general guidance and does not constitute specific advice. The industry consultation process on implementation of replacement rates for LIBOR continue to evolve and Bank ABC will provide further guidance in due course. We will also contact clients directly to discuss individual contract arrangements. 
 ​
​What is LIBOR?​
​The London Interbank Offered Rate (LIBOR) is used in the calculation of interest and other payments for many loans, derivatives, bonds and other financial transactions both in the UK and overseas.

LIBOR is a set of benchmark interest rates that provide an indication of the average rates at which panel banks can borrow wholesale, unsecured funds for set periods in particular currencies. It is calculated and published daily across a range of currencies (GBP, USD, EUR, JPY and CHF) and maturities (overnight, one week, one month, two months, three months, six months and one year). 

It is estimated that LIBOR underpins around $300tn ($30tn in sterling markets) of financial contracts including derivatives, bonds and loans. 
 
​ ​ ​ ​What is expected to replace LIBOR?
​Alternative benchmark interest rates have been nominated as replacements for LIBOR. These include the following rates:

​Currency ​Alternative rate ​Nature Description​
​Euro area ​Euro short term rate (€STR) ​Unsecured Unsecured rate that captures overnight wholesale deposit transactions​
​United Kingdom ​Sterling Overnight Index Average (SONIA) ​Unsecured ​Unsecured rate that covers overnight wholesale deposit transactions
​United States of America ​Secured Overnight Financing Rate (SOFR) ​Secured ​Secured rate that covers multiple overnight repo market segments
​Switzerland Swiss Average Rate Overnight (SARON)​ ​Secured ​Secured rate that reflects interest paid on interbank overnight repo rate
​Japan ​Tokyo Overnight Average Rate (TONAR) ​Unsecured ​​Unsecured rate that captures 
overnight call rate market​
  
 What does this mean to our clients?
 For LIBOR-linked contracts that expire prior to the end of 2021, wherever possible we will allow the contract to complete naturally. However, the market adoption of the alternative benchmark interest rates might place liquidity constraints on LIBOR, therefore we would need to review all contracts, regardless of expiration date.

For LIBOR-linked contracts that expire in 2022 or beyond, your Relationship Manager will contact you to discuss the transition to alternative benchmark interest rates.

For new contracts, we are anticipating the requirement to move away from LIBOR and the wording in our new contracts allows for discussion and negotiation with our clients.

There are some important differences between LIBOR and the proposed alternative benchmark interest rates.  LIBOR is a forward looking term rate, which means that the LIBOR rate for an interest period is set at the start of that period with payment due at the end.  As such, this provides certainty of funding costs to assist cashflow management.

In contrast, the alternative proposed benchmark interest rates are mostly backward looking overnight rates and do not reflect a term structure. The transition to the alternative benchmark interest rates may have pricing, cashflow, accounting and operational implications for you and your business.
  
 What actions should you be considering?
The Bank of England, Prudential Regulation Authority and Financial Conduct Authority are collaborating with industry groups to determine how best to transition to the alternative benchmark interest rates and Bank ABC is actively monitoring these developments and will engage with you further to minimise impact to your business.

In the interim, you may wish to consider the following actions:
  • Understand the reasons for the LIBOR transition and the features of the alternative benchmark interest rates (please see links below).
  • Determine all LIBOR-linked transactions or products that you hold with all of your financial service providers, including maturity dates and legal contract language.
  • Consider the impact of transitioning from LIBOR to alternative benchmark interest rates.
  • Consider whether you wish to seek advice from your financial or legal advisers.
  
 Where can you find more information?
More information on SONIA and LIBOR transition in the UK is available from the Risk Free Rate (RFR) Working Group: 

https://www.bankofengland.co.uk/markets/transition-to-sterling-risk-free-rates-from-libor​   

https://www.bankofengland.co.uk/markets/sonia-benchmark  

Additional information can be found here: 

 
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