Reference rate reform: The end of the LIBOR era
The London Interbank Offered Rate (LIBOR) expires in 2021, signalling the transition to alternative reference rates (ARR). To ensure a smooth transition, now is the time to put clear and actionable measures in place.
During 2012 it came to light that LIBOR was susceptible to manipulation and due to the extensive use of LIBOR as a reference rate, regulators globally launched transition programmes to establish and implement benchmarks that are credible and robust.
As LIBOR has been the interest rate benchmark for calculating interest rates of financial products since the mid-80s, this shift will fundamentally change how business is done and capital is priced - affecting financial services providers and clients alike. While GBP LIBOR is being replaced by the Sterling Overnight Indexed Average (SONIA), the Secured Overnight Financing Rate (SOFR) replaces USD LIBOR. The other LIBORs will also be replaced, i.e. European Short Term Rate (€STR) in place of EUR LIBOR (and EURIBOR), Tokyo Overnight Average (TONA) in place of JPY LIBOR and Swiss Average Rate Overnight (SARON) in place of CHF LIBOR.
Two key features on the new reference rates are that they overnight rates only (i.e. no terms rates currently) and these rates are backward-looking because they are based on actual daily transactions, compared to the forward-looking nature of LIBOR resulting from the submission based methodology from panel banks.
Crucially, all clients with LIBOR referencing contracts should assess the impact of the transition on their business, along with assessing the proactive measures to take to minimise disruption.
We have established a dedicated project office to coordinate Group transition efforts and place specific focus on areas critical to successful transitioning for our clients.
We are working closely with authorities to manage operational, client and regulatory readiness. Tracking transition impacts and timelines and developing plans to mitigate risks to the way we do business. Find out how we are preparing for the transition.
The first step will be to assess your exposure of your contract or portfolio of contracts to LIBOR, specifically contracts that will still be live beyond 2021 and identify how the discontinuation of LIBOR will affect the operation of the contract.
In the event that you are affected by the discontinuation, you will have to review the fallback language regarding LIBOR’s cessation and identify risk-mitigating actions, such as renegotiation with contract stakeholders.
Establish which ARR will replace LIBOR in your contracts, and which new risks they introduce. Be prepared to negotiate to maintain the economic terms of the contract, as well as referencing the ARR in new contracts. The table below lists the five LIBOR benchmark rates and the ARR replacement rate:
|Existing benchmark||Preferred Alternative Risk-Free Rate||Characteristics||Further transition detail and milestones|
|GBP LIBOR||Sterling Overnight Index Average (SONIA)||Unsecured, fully transaction based, scope expanded to include overnight transactions negotiated bilaterally and with brokers||Consult the Sterling Risk Free Reference Rate Working Group’s website|
|USD LIBOR||Secured Overnight Financing Rate (SOFR)||Secured, fully transaction based, first published April 2018||Consult the Alternative Reference Rate Committee (ARRC) website|
|EUR (EURIBOR/EONIA)||Euro Short-Term Rate (ESTR)||Unsecured, based on overnight borrowing costs of banks, published October 2019||For detail around the transition from EONIA to ESTR, consult the Working Group on Euro Risk Free Rates website|
|CHF LIBOR||Swiss Average Rate Overnight (SARON)||Secured, reflects interest paid interbank overnight, established rate||Consult the National Working Group on Swiss France Reference Rates website|
|JPY (JPY LIBOR, TIBOR, Euroyen TIBOR)||Tokyo Overnight Average Rate (TONAR)||Unsecured, fully transaction based, reflecting the uncollateralised overnight call rate market, established rate||Consult the Study Group of Market Participants website|
The interbank offered rates’ (IBOR) transition to risk-free rates (RFR) marks a significant and unprecedented challenge for the financial services industry. Learn more about the role of fallback language in the transition process away from IBORs and how it is used to mitigate some of the risks for parties exposed to these benchmark rates once they are discontinued.