The London Interbank Offered Rate (LIBOR)
The London Interbank Offered Rate (LIBOR) is the most widely 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 tenors (from overnight to 12 months) and is used worldwide in the calculation of interest and other payments for many loans, derivatives, bonds and other financial instruments.
Following the LIBOR fixing scandal that was uncovered in 2011 and the general decline in the importance of interbank lending in the financial markets, global financial regulators and standard setters pushed for a move away from using LIBOR as a benchmark.
Certain interest rate benchmarks including LIBOR, EURIBOR 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 Index Average(SONIA) in 2018 as a replacement of the Sterling LIBOR.
What is the international reform of interest rate benchmarks?
Due to the manipulation of IBOR reference rates uncovered in 2011, IOSCO (International Organization of Securities Commissions) initiated reforms of these benchmark rates. In 2016, the European Union adopted the Benchmark Regulation (EU BMR). Alternative risk-free reference rates (RFRs) also referred to as Alternative Reference Rates (ARRs) are being developed and are already partly established. Existing IBOR references are to be reformed or replaced based on the new RFR benchmarks. Interest rate benchmarks are referenced in a wide array of financial products, including loans, floating rate notes, derivatives, deposits, trade finance and securitizations. This reform aims for a stronger market integrity and consumer protection.
The development of the RFR methodology and the provision of industry conventions and guidelines for implementation is carried out by national working groups for each currency area. In order to achieve a smooth transition these reforms are also supported by global regulators, industry working groups and trade associations.
Risk Free Rates and LIBOR cessation dates
Overnight Risk Free Rates (RFRs) are benchmarks, which are overnight rates derived from actual transactions. 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, in some jurisdiction term rates are being developed.
USD | GBP | JPY | CHF | EUR | |
---|---|---|---|---|---|
Alternate Reference Rate | Secured Overnight Financing Rate (SOFR) | Sterling Overnight Index Average (SONIA) | Tokyo Overnight Average Rate (TONAR) | Swiss Average Overnight Rate (SARON) | Euro Short Term Rate (€STR) or EURIBOR |
How is NBB responding to this?
The National Bank of Bahrain supports the move to more robust and reliable benchmark rates. We are closely following the work being done by the regulators, industry bodies, and trade associations in order to achieve a smooth transition of the international benchmarks and will continue to update you throughout the transition phase. Furthermore, NBB may adhere to the update of the ISDA protocol to ensure industry standard derivative offerings with our clients or alternatively enter bilateral agreements.
Accordingly, we have 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 are also evaluating existing contracts across all products to determine the impact of the discontinuation of LIBOR and other benchmarks and to address potential amendments to those contracts.
What does this mean for our clients?
We will work closely with our clients on the transition, taking into consideration their concerns and will provide further information and 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 NBB 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.
If your facility terminates (or final rate fixing is for any product) before the below dates for the cessation of below mentioned LIBORs, it can mature naturally, with no required action.
Please note that the extended timeline until 30th June 2023 is only usable for certain legacy transactions; new business offered post 31st December 2021 will not be executed on a LIBOR basis and hence will not be impacted and or migrated.
Our Client Approach
1. Factsheet
2. Agreement transition terms: Clients will be approached to decide on the new terms of the contracts as highlighted below.
3. Pricing:
4. Execution:
5. Post transitioning support:
Chronology of latest developments
On 30th November 2020, ICE Benchmark Administrator (IBA), the FCA regulated and authorised administrator of LIBOR, announced that it will consult in December 2020 on its intention to cease the various LIBOR currency and tenor settings. Subject to confirmation following the IBA consultation, the cessation timelines are expected to vary.
On the same day, the US Federal Reserve System, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation announced that no new contracts referencing USD LIBOR can be issued beyond 31st December 2021. The UK’s FCA has already indicated that GBP LIBOR referencing contracts cannot be issued beyond Q1 2021, if their maturity date extends beyond 31st Dec 2021.
On 5th March 2021, the FCA announced the future cessation and loss of representativeness of all LIBOR benchmarks as per the above timelines published by the IBA.
Regulators in the USA, the UK and the Eurozone area continue to work towards developing term rates based on RFR, which can offer a forward-looking curve for associated contracts. Preliminary versions of Term SONIA (in the UK) have been available since 11th January 2021.
Credit Adjustment Spread
A credit adjustment spread aims to reduce the economic impact of transitioning from LIBOR to RFRs. One of the differences between LIBOR and RFRs is that LIBOR implies an interbank credit spread which contains a term liquidity premium to reflect the credit risk associated with lending for different periods. Hence, historically RFRs have been lower rates than LIBOR.
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 do not include a credit premium, hence, to address this difference the market has introduced the concept of a Credit Adjustment Spread (CAS) which is added to the Risk-Free Rate (RFR). Therefore, the all-in rate for a loan transitioned to Risk Free Rates is comprised of three elements: The RFR, plus the CAS plus the agreed commercial margin.
Following the cessation announcement of given LIBOR tenors, which was published on 5th March 2021, official spread recommendations have been fixed for ISDA-framework. Similar approaches are currently being adopted for the loan market. The fixed CAS percentages can be found here.
The London Interbank Offered Rate (LIBOR) is the most widely 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 tenors (from overnight (O/N) to 12 months) and is used worldwide in the calculation of interest and other payments for many loans, derivatives, bonds and other financial transactions.
Further definitions in the context of LIBOR-Transition can be found in the LMA Glossary.
Due to the manipulation of IBOR reference rates uncovered in 2011, IOSCO (International Organization of Securities Commissions) initiated reforms of these benchmark rates. In 2016, the European Union adopted the Benchmark Regulation (EU BMR). Alternative risk-free reference rates (RFRs) are being developed and are already partly established. Existing IBOR references are to be reformed or replaced based on the new RFR benchmarks.
The development of the RFR methodology and the provision of industry conventions and guidelines for implementation is carried out by national working groups for each currency area.
The announced cessations dates by ISDA can be found in the table below.
It should be noted that the IBOR transition is proven to be highly dynamic with the challenge that the emerging market standards and future product designs are still evolving, and thus, changes are possible as the transition progresses.
Most notably, the USD LIBOR will be replaced by the Secured Overnight Financing Rate (SOFR).
LIBOR Setting | Last date of publication/ representativeness | Index Cessation Effective Date | Spread Adjustment Fixing Date | Interpolation | Potential for Non- Representative, Synthetic Publication |
---|---|---|---|---|---|
USD LIBOR | |||||
Overnight and 12-month USD LIBOR settings | June 30, 2023 | July 1, 2023 | March 5, 2021 | N/A | N/A |
1-week and 2-month USD LIBOR settings | December 31, 2021 | July 1, 2023 | March 5, 2021 | January 1, 2022 through June 30, 2023 | N/A |
1-month, 3-month and 6-month USD LIBOR settings | June 30, 2023 | July 1, 2023 | March 5, 2021 | N/A | July 1, 2023 onward |
GBP LIBOR | |||||
Overnight, 1-week, 2- month and 12-month GBP LIBOR settings | December 31, 2021 | January 1, 2022 | March 5, 2021 | N/A | N/A |
1-month, 3-month and 6- month GBP LIBOR settings | December 31, 2021 | January 1, 2022 | March 5, 2021 | N/A | January 1, 2022 onward |
EUR LIBOR | |||||
All EUR LIBOR settings | December 31, 2021 | January 1, 2022 | March 5, 2021 | N/A | N/A |
JPY LIBOR | |||||
Spot next, 1-week, 2- month and 12-month JPY LIBOR settings | December 31, 2021 | January 1, 2022 | March 5, 2021 | N/A | N/A |
1-month, 3-month and 6- month JPY LIBOR settings | December 31, 2021 | January 1, 2022 | March 5, 2021 | N/A | January 1, 2022 through December 31, 2022 |
CHF LIBOR | |||||
All CHF LIBOR settings | December 31, 2021 | January 1, 2022 | March 5, 2021 | N/A | N/A |
Referencing “Our Client Approach”, we have put together a 5-step Client Approach which aims to achieve a systematic transition programme for our clients. In the initial phase the NBB Group will reach out to you via a letter which will explain the transition options available to our clients and will include a factsheet which provides information on the outstanding transactions between you and NBB Group which are in scope for transition / amendment.
Furthermore, as markets are still developing we recommend that you to assess your LIBOR-referenced exposures and stay up-to-date with developing regulations / market standards of the RFR Working Groups (please find links in “References” section).
In the next step, your relationship manager will walk you through the following topics:
The transitioning of existing contracts will be executed in one of the following alternatives which we intend to make available to our clients:
Active conversion - Proactively negotiation regarding the conversion of your transactions with the NBB Group in advance of LIBOR cessation. This will allow for defined outcomes in terms of timing and structure of transactions post conversion; or
Fallback conversion - you allow your existing LIBOR transactions to incorporate market-standard fallback provisions which will be triggered by the LIBOR cessation event and rule.
RFR working groups and regulators generally support market participants to actively transition their legacy LIBOR contracts instead of relying on fallback language. Regulators have also strongly encouraged market participants to use RFRs in newly originated facilities. This aims for a smoother transition away from LIBOR. Additionally, regulators believe that an active transition is the best way parties can have certainty over both the continued operation and the future economics of their contracts. As such, market participants have been strongly encouraged to focus on an active transition.
Fallback language, if present, typically determines the steps for the replacement rate in the form of a waterfall (a set hierarchy of available alternatives) or an amendment process. However, during the IBOR-Transition process, NBB Group will evaluate whether existing contracts do contain appropriate fallback language or whether amendments must be made.
LIBOR is a forward-looking or ‘term’ rate quoted for five currencies (USD, GBP, CHF, JPY, and EUR) and seven tenors (O/N, 1W, 2M, 3M, 6M and 12 M). Hence, the LIBOR-linked rate in a contract is known at the start of the relevant interest period.
All the RFRs are overnight rates and therefore the rate is not known in advance. One approach is to create a term rate from these overnight rates is on a backward-looking basis. The backward-looking term rate can be constructed by calculating a simple or compounded average of the daily fixings of the RFR over the given term. This means the rate is not available until the end of the term, so the accounting for a three-month or six-month rate based on RFRs requires significantly different mechanics.
Transitioning away from LIBOR to a RFR requires the use of a credit adjustment spread to account for the fact that IBORs typically incorporate a bank credit spread and liquidity premium, while RFRs do not (see section “Credit Spread Adjustment”)
In May 2021, the Alternative Reference Rates Committee in the US (ARRC) announced that it has selected CME Group as the administrator of a term rate based on SOFR.
In July 2021, the ARRC formally recommended and finally endorsed the SOFR term rate.
The ARRC supports the use of SOFR Term Rate in addition to other forms of SOFR for business loan activity —particularly multi-lender facilities, middle market loans, and trade finance loans—where transitioning from LIBOR to an overnight rate has been difficult and where use of a term rate could be helpful in addressing such difficulties. The ARRC also recognizes that the SOFR Term Rate may also be appropriate for certain securitizations that hold underlying business loans or other assets that reference the SOFR Term Rate and where those assets cannot easily reference other forms of SOFR.
The ARRC does not support the use of the SOFR Term Rate for the vast majority of the derivatives markets, because these markets already reference SOFR compounded in arrears and transitioning derivatives markets to the more robust overnight risk-free rates (RFRs) is essential to ensure financial stability as emphasized by the Financial Stability Board. The ARRC recommends that any use of SOFR Term Rate derivatives be limited to end-user facing derivatives intended to hedge cash products that reference the SOFR Term Rate. This limitation is intended to avoid use that is not in proportion to, or materially detracts from, the depth of transactions in the underlying derivatives markets that are essential to the construction of the SOFR Term Rate over time.
In addition, the ARRC recommended best practices and published conventions.
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 NBB 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.
References
Disclaimer
All clients are advised to obtain their own advice prior to making any decision or taking any action whatsoever based hereon, and NBB Group disclaims any liability for any direct, indirect or consequential damage or losses that that may be suffered from using or relying on the information contained herein, even if notified of the possibility of such damage or loss, and irrespective of whether or not independent advice has been obtained.