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The replacement of LIBOR
18/02/2021
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 implementation of replacement 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.  


Background

It is estimated that LIBOR underpins around US$ 250 trillion of financial contracts (US$ 30 trillion in sterling markets alone) and was once referred to as the “world’s most important number”.  

Following the LIBOR fixing scandal 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 that LIBOR should be replaced with transaction based Risk Free Rates (RFRs).  

In 2017, the Financial Conduct Authority (FCA) announced its intention to stop compelling banks to submit the rates required to calculate LIBOR.  UK and global regulators expect financial market participants to complete the steps necessary to cease using LIBOR by the end of 2021.  It is currently expected that the most frequently used USD LIBOR tenors will be available until June 2023 for legacy contracts only.  

There are shorter timeframes for sterling based facilities (and multi-currency facilities that include sterling), namely:

  • From 1 April 2021, no issuance of new GBP LIBOR facilities that mature in 2022 or beyond.
  • By 30 September 2021, legacy GBP LIBOR contracts must be transitioned to RFRs.

 

 
What is replacing LIBOR?

The alternatives to LIBOR vary according to the nature of the product involved and can be summarised as follows:

  • Backward looking risk free rates.  These are calculated in arrears based on actual overnight lending rates during the relevant period.  Backward looking rates are suitable for most term lending products such as Corporate Loan facilities and Real Estate Finance transactions.  One major difference between LIBOR and backward looking RFRs is that the interest rate is not known at the outset and will only be fixed near the end of the interest period.  Consequently, this introduces uncertainty regarding the amount of actual interest that is payable at each due date. 
  • Forward looking risk free term rates.  These will be published by benchmark administrators and are necessary for Trade Finance and Export Finance transactions such as Forfaiting, Invoice Discounting and other transactions that involve a discounted up-front payment. Term rates may also form a suitable basis for calculating the profit rate on certain Islamic products and for transactions involving Emerging Markets.
  • Bank Base Rate.  This may be suitable for retail products such as mortgages. 


The following table provides a summary of the key deadlines for each currency and the alternative backward looking and forward looking risk free rates where available:


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)
LIBOR withdrawal date 31 December 2021 31 December 2021 Overnight, 1M, 3M, 6M & 12M to be provided until June 2023 for legacy contracts only 31 December 2021 Includes discontinuation of EONIA EURIBOR is not being withdrawn 31 December 2021 31 December 2021
Deadline to convert existing contracts 30 September 2021 for contracts maturing post 31 December 2021
Existing contracts can mature naturally until 31 December 2021
31 December 2021 for contracts maturing post 30 June 2023
Existing contracts can mature naturally until 30 June 2023
31 December 2021 for contracts maturing post 31 December 2021
Existing contracts can mature naturally until 31 December 2021
31 December 2021 for contracts maturing post 31 December 2021
Existing contracts can mature naturally until 31 December 2021
31 December 2021 for contracts maturing post 31 December 2021
Existing contracts can mature naturally until 31 December 2021
Date from which no new LIBOR linked contracts can be issued 31 March 2021 for contracts maturing beyond 2021 31 December 2021 31 December 2021 30 September 2021 30 September 2021
Alternative reference rate for most Term Loan Facilities, Derivatives & some deposits SONIA compounded in arrears
Administered by Bank of England since August 2020
SOFR compounded in arrears or simple average in arrears
Administered by IBA since June 2020
€STR
Published since October 2019
SARON
Published since March 2020
TONAR
Published since June 2016
Term rate for Trade Finance, Islamic Finance & Export Finance products Term SONIA

Published by ICE, Refinitiv & FTSE Russell since January 2021
Term SOFR

Expected to be published 30 June 2021
NA – EURIBOR is an alternative No term rate available Term TONAR is under consideration

 

What does this mean for our clients?

For LIBOR linked contracts that expire before the end of 2021 (or before the end of June 2023 for existing USD LIBOR linked contracts), we will allow the contract to mature naturally wherever possible. However, we are reviewing 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 an appropriate RFR.

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

As mentioned above, there are some important differences between LIBOR and the proposed RFRs.  Therefore, the transition to the RFRs may have pricing, cash flow, accounting and operational implications for you and your business.  The two key differences for backward looking RFRs are:

  • they are calculated at the end of the period based on overnight rates, which means that the interest payable is not known until the end of the relevant borrowing period, and
  • they do not embed an interbank credit component.  This will be addressed by including a credit adjustment spread to the RFR.
  
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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