What is the international reform of interest rate benchmarks?
Major central banks and regulators have decided to transition from the existing Interbank Offered Rates (IBORs) to alternative Risk-Free Rates (RFRs), also referred to as Alternative Reference Rates (ARRs).
Interest rate benchmarks are referenced in a wide array of financial products, including loans, floating rate notes, derivatives, deposits, trade finance and securitisations. In order to strengthen market integrity and consumer protection, a number of alternative benchmark rates have been developed in the major financial markets to replace the LIBOR and other reference rates that are being discontinued.
This is the biggest change that financial markets will undergo in recent times. Bank ABC is closely following the direction of global regulators, industry working groups, and trade associations to facilitate a smooth transition from current interest rate benchmarks to alternative reference rates.
The London Interbank Offered Rate (LIBOR)
Following the LIBOR fixing scandal that was exposed in 2011 and the general decline in the importance of interbank lending in the financial markets, global financial regulators decided that markets must move away from using LIBOR as a benchmark and have it replaced.
The London Interbank Offered Rate (LIBOR) has been the most commonly used set of IBORs that are based on the rates at which prime banks estimate they can borrow from each other. LIBOR is calculated and published daily for five currencies (GBP, USD, EUR, JPY and CHF) over a range of maturities (from overnight to one year) and used worldwide in the calculation of interest and other payments for many loans, derivatives, bonds and other financial transactions. At the end of December 2021, all GBP, JPY & CHF LIBOR rates ceased publication. The USD LIBOR rates will continue to be published until the end of June 2023 with the exceptions of the 1 week and 2 month rates which have already been discontinued.
Certain interest rate benchmarks including LIBOR and EONIA are being reformed or replaced. If any of your financial products or internal processes refer to these rates or other interest rate benchmarks, the following information is relevant for you.
Most notably, the USD LIBOR will be replaced by the Secured Overnight Financing Rate (SOFR), and the UK has reformed the Sterling Overnight Interbank Average Rate (SONIA) in 2018 as a replacement of the Sterling LIBOR.
Alternative Reference Rates
Alternative Reference Rates (ARRs) are benchmarks generally based on overnight deposit rates. They are considered to be more robust as they are based upon a larger volume of observable transactions. For products that require a forward-looking rate, such as Trade & Islamic Finance, the markets have developed ‘Term Rates’. These are available for SONIA and SOFR. The Term Rates have a limited scope of application which have been defined in releases of ‘best practices’ by the ARRC in the USA, and the WGSRFR in the UK. The Bank’s Relationship Managers will be pleased to advise clients on an optimal solution.
Alternate Reference Rate||Sterling Overnight Index Average (SONIA)||Secured Overnight Financing Rate (SOFR)||Euro Short Term Rate (€STR)
|Swiss Average Overnight Rate (SARON)||Tokyo Overnight Average Rate (TONAR)|
Alternative Reference Rate for most Commercial Loan Facilities, Derivatives & some deposits||SONIA compounded in arrears
Administered by Bank of England since August 2020
|SOFR either compounded in arrears or simple average in arrears
Administered by IBA since June 2020
Published since October 2019
Published since March 2020
Published since June 2016
|Term rate for Trade Finance, Islamic Finance & Export Finance products||Term SONIA
Published by ICE & Refinitiv since January 2021
Approved by the ARRC on 29 July 2021 and published by CME
|NA – EURIBOR is an alternative||No term rate available||Term TONAR is under consideration|
How is Bank ABC responding to this?
Bank ABC welcomes the move to more robust and reliable benchmark rates. We are closely following the work being done by regulators, industry bodies, and trade associations to facilitate a smooth transition of the international benchmarks and will continue to update our clients throughout the various transitions.
Furthermore, Bank ABC has adhered to the ISDA 2020 IBOR Fallbacks Protocol to ensure frictionless derivative offerings with our clients.
In 2020, Bank ABC established a Group-wide initiative to identify, assess, and monitor risks associated with the discontinuation or unavailability of benchmarks, including LIBOR, and the transition to Alternative Reference Rates. We evaluated existing contracts across all products to determine the impact due to the discontinuation of LIBOR and other benchmarks, and to address potential changes to those contracts. This initiative will continue until all LIBOR referencing contracts maturing after June 2023 are transitioned to an alternative reference rate.
What does this mean for our clients?
We are working closely with our clients on the transition, taking into consideration their concerns and will provide updates as necessary. For further guidance on how to prepare for the possibility that LIBOR or other benchmark rates will be discontinued or materially changed, please consult your Bank ABC relationship manager. We recommend that you also consult your own legal, tax, financial, and other professional advisors for more specific guidance.
Some benchmark rates are being reformed or will be discontinued and replaced with alternative benchmark rates that meet the new regulatory and market requirements. This may impact the products and services which are currently made available to you and those which we will provide in the future.
Bank ABC has already transitioned GBP, JPY & CHF LIBOR referencing contracts and is working with the Bank’s clients to complete the USD LIBOR referencing deals by 30 June 2023. The Bank will liaise with all of its clients to transition the USD LIBOR contracts outstanding in our books before the cessation of the remaining LIBOR rates.
The Bank has adopted a ‘No New LIBOR’ policy from 1 January 2022 under which all new USD, GBP, JPY & CHF contracts will reference an alternative reference rate, rather than LIBOR.
Credit Adjustment Spread
One of the differences between LIBOR and ARRs is that LIBOR embeds an interbank credit spread which contains a term liquidity premium to reflect the credit risk associated with lending for different periods. Therefore, the all-in interest rate for a LIBOR based loan is simply the LIBOR rate for the relevant term plus the bank’s commercial margin. In contrast ARRs do not include a credit term liquidity premium, so to address this difference the market has introduced the concept of a Credit Adjustment Spread (CAS) which is added to the Alternative Reference Rate (ARR). Therefore, the all-in rate for a loan transitioned to an Alternative Reference Rate is comprised of three elements: The ARR, plus the CAS plus the agreed commercial margin.
The fixed CAS percentages issued by ISDA can be found here.
Any further questions?
For more information on the reform of benchmark rates, please visit the various websites below. You can also reach out directly to your Bank ABC relationship manager. We will continue to update you as interest rate benchmark reforms and transitions develop. The information presented here is not intended to be a complete or exhaustive overview.
Further external information can be found here