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The replacement of LIBOR
14/04/2021
The London Interbank Offered Rate (LIBOR) is a set of benchmark interest rates that are based on the rates at which banks estimate they can borrow from each other.  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) and is used world-wide in the calculation of interest and other payments for many loans, derivatives, bonds and other financial transactions.

For the majority of its currencies and tenors, LIBOR will no longer be published after the end of 2021. The below outlines what this means for our customers and what actions to consider. 

This briefing provides an update on the status of the replacement risk free rates for LIBOR.  It is provided as general guidance and does not constitute specific advice.  We are contacting clients directly to discuss individual contract arrangements.   
 
Risk Free Rates (RFRs) per currency

RFRs 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 such as Trade & Islamic Finance, a forward looking rate is either currently available (SONIA or EURIBOR) or under consideration (SOFR, SARON & TONAR).


Alternate reference rate Sterling Overnight Index Average (SONIA) Secured Overnight Financing Rate (SOFR) Euro Short Term Rate (€STR) or EURIBOR 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 2018
 SOFR either compounded in arrears or simple average in arrears

Administered by New York Fed since 2018​​
 €STR
Published by ECB since 2019
or EURIBOR
Published by European Money Markets Institute since 1999
 SARON
Administered by SIX Swiss Exchange since 2020​
 TONAR
Administered by Bank of Japan since 2016​
​Term rate for Trade Finance, Islamic Finance & Export Finance products ​Term SONIA
Published by ICE & Refinitiv since January 2021​
​Term SOFR is under consideration EURIBOR
Published by European Money Markets Institute since 1999​​
​Term SARON is under consideration ​Term TONAR is under consideration

 

LIBOR cessation event

 On 5 March 2021 the Financial Conduct Authority (FCA) announced the future cessation or loss of representativeness of 35 LIBOR benchmark settings currently publicised by ICE Benchmark Administration (IBA).  

The FCA’s announcement coincided with a statement from the IBA on its intention to cease the publication of LIBOR settings.  The result is that LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after the following dates:​​

  • 31 December 2021 in the case of all sterling, euro, Swiss franc, Japanese yen settings and the 1-week and 2-month US dollar settings; and
  •  30 June 2023 in the case of the remaining US dollar settings.
Further information can be found here: 
  
What happens next?​

​Contract type ​Fixing approach
Existing contracts that mature before the above dates. ​Bank ABC can continue to fix against LIBOR.  This includes contracts where the final fixing date is before the above dates even if the facility expires after 31 December 2021 (or 30 June 2023 for the remaining USD settings).
Existing contracts that mature after the above dates. ​Bank ABC will contact clients to transition to risk free rates as LIBOR will no longer be available. The exception is where the final fixing date is before the cessation of the relevant LIBOR as mentioned above. 
New GBP contracts  ​From the 1st April 2021 all new GBP contracts must be written using a Risk Free Rate as opposed to LIBOR.
New USD contracts ​From the 1st January 2022 all new USD contracts must be written using a Risk Free Rate as opposed to LIBOR.
 

  
What this means to you

If your facility (or final rate fixing) is before the above dates for the cessation of LIBORs, no action is needed.

Otherwise, we will contact you to discuss an amendment to your contract outlining the transition to risk free rates.  

For new facilities, we will ensure that the contract language reflects RFRs or, where these are not yet available, allows for discussion with you when RFRs are available.

  
Credit adjustment spread (CAS)

LIBOR contains an interbank credit term spread. 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, RFRs are an overnight rate and do not include a credit term spread.  To address this difference for existing contracts that need to be amended, the market convention is to apply a Credit Adjustment Spread (CAS). Therefore the all-in rate for a loan priced using risk free rates may be comprised of three elements: the RFR (e.g. SONIA/SOFR), plus the CAS plus the bank’s commercial margin.

For new contracts, it is expected that they will be priced using just the relevant RFR and a commercial margin, with any applicable credit adjustment spread incorporated within the commercial margin.

ISDA have fixed the credit adjustment spread percentage for derivatives, with the most commonly used ones fixed at:

​Tenor ​GBP ​USD
​1 month ​0.0326 0.11448​
​3 month ​0.1193 ​0.26161
 

​​The loan market is expected to follow suit in applying a credit adjustment spread.​

The December 2020 publication from the UK’s Working Group on Sterling Risk Free Rates describes approaches and considerations for transition from LIBOR to RFRs, including the application of the credit adjustment spread.  Kindly note that the LIBOR cessation event has occurred since this publication was issued. ​

Credit adjustment spread methods for active transition of GBP LIBOR referencing loans – December 2020 (bankofengland.co.uk)​

 

 
What actions should our clients be undertaking?

The Bank of England, Prudential Regulation Authority and Financial Conduct Authority are collaborating with industry groups such as UK Finance, the Loans Market Association and the Association of Corporate Treasurers on the practical steps to transition to RFRs.  Bank ABC is actively monitoring these developments and will engage with our clients to ensure that the transition is completed in an appropriate and mutually satisfactory manner. 

We advise undertaking the following actions:

  • Understand the reasons for the LIBOR transition and the features of RFRs (please see links below for further information).
  • 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 RFRs.
  • Consider whether you wish to seek advice from your financial or legal advisers.
  • Ensure that your systems, operational processes, risk management practices and financial control and reporting arrangements are ready for the transition. 
  
Where can you find more information?
More information on SONIA and LIBOR transition in the UK is available from the Risk Free Rate Working Group:


Additional information can be found here: 
 ​

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