IBOR Transition FAQs

In 2013, the G20 commissioned the Financial Stability Board (FSB) to review systemically important interest rate benchmarks.

The resulting FSB report, published in July 2014 recommended:

• Strengthening the IBORs, in particular, by anchoring them to a greater number of transactions, where possible, and improving the processes and controls around submissions;
• Identifying Risk-Free Rates (RFRs) and where suitable, encouraging derivative market participants to transition new contracts to an appropriate RFR.

The approach taken by the relevant Central Bank-led RFR working groups is to encourage the voluntary adoption of RFRs, rather than to mandate a transition away from LIBOR. RFRs will therefore co-exist with the LIBOR as long as the LIBOR is published, offering market participants the option of using an RFR for new transactions.

To encourage the adoption of RFRs, various RFR Working Groups across the world have published recommendations for interim milestones prior to the cessation of LIBORs. Please refer to question 2.3 for more information on the key regulatory guidance.

Although the adoption of an RFR is voluntary, the heightened risk of discontinuation of LIBOR after the end of 2021 makes it essential that market participants consider moving to RFRs or to another alternative rate (for example, a central bank rate) and that they have the appropriate fallback language in existing contracts referencing LIBOR.

At present, we envisage that all existing contracts should be switched to RFRs or other alternative rates before LIBOR ceases to exist.

No, the outcomes of benchmark reform will vary by jurisdiction. While some jurisdictions have been able to continue with a multi-rate approach (i.e. developing a new RFR alongside maintaining an IBOR), in others, a multi-rate approach is not possible because the wholesale unsecured funding markets that underpin certain IBORs have become too thin to support robust IBOR reference rates. In particular, in the case of LIBOR, where the lack of applicable wholesale unsecured funding markets is a fundamental problem and continues to exist, there is no likelihood of a change, and other measures which purport to measure bank credit risk in this way will suffer from the same problems. The continued reliance of global financial markets on LIBOR was therefore posing a risk to financial stability.

Authorities have warned that market participants should expect LIBOR to cease to be published once the support of competent authorities for the benchmarks ends at the end of 2021, and that there is a risk that LIBOR could be found no longer to be representative of the underlying market it purports to measure, due to a lack of underlying transactions.

The UK Financial Conduct Authority (the 'FCA') indicated that it would make an announcement in 2021 on the future cessation and loss of representativeness of LIBOR, and on 05 March 2021, the FCA published the expected announcement. Further details on this are contained below.

FAB is not currently aware of any forthcoming changes to the Emirates Interbank Offered Rate administered by the Central Bank of the United Arab Emirates, which is also an IBOR and more commonly referred to as "EBOR" or "EIBOR". The Central Bank of the United Arab Emirates may, in the future, mandate reforms to this benchmark rate, and advance notice of the timing or nature of such changes may not be available to market participants.

However, as mentioned above, use of RFRs as an alternative rate is not mandatory and there may be cases where it is more appropriate to replace (L)IBOR with a different rate (for example, a central bank rate).

The adoption of liquidity in RFRs is gathering steam and will ultimately be driven by the increased usage of the rate by end-users. It is anticipated that the adoption of RFRs will be accelerated by the adoption of SOFR and ESTR discounting by clearing houses.

In addition, ISDA published a supplement amending the 2006 ISDA definitions to incorporate new benchmark ‘fallbacks’ along with the ISDA 2020 IBOR Fallbacks Protocol (the 'ISDA Fallbacks Protocol'). FAB has adhered to the ISDA Fallbacks Protocol. More information on the ISDA Fallbacks Protocol can be found here. Benchmark fallbacks are replacement rates that would apply to derivative trades referencing a benchmark. These would take effect if the relevant benchmark becomes unavailable while market participants continue to have exposure to that rate. In the case of LIBOR, the fallbacks will be adjusted versions of the RFRs.

The FCA, on 05 March 2021, announced LIBOR cessation and non-representativeness dates¹. Please refer to the table below for details. The link to the above-mentioned FCA’s announcement is here. Please read the brief information provided in the table below, in conjunction with the details provided in FCA’s announcement.

“LIBOR cessation” refers to the permanent cessation of publication of the respective LIBOR rates. “Non-Representativeness” refers to FCA announcing that the respective LIBOR is no longer representative of the underlying market that it is intended to measure, and that representativeness will not be restored.

Please note, the LIBOR settings published beyond the “Non-Representativeness” dates are only to be used in “tough legacy” contracts. The use of these LIBOR settings for new transactions is prohibited for UK regulated firms.

In addition to the above, EONIA (Euro Overnight Index Average) is expected to be discontinued on 03 January 2022. SOR (Singapore Dollar Swap Offer Rate) relies on USD LIBOR for computation and its cessation dates are expected to be aligned with USD LIBOR cessation / non-representativeness dates.

The FCA announcement will have activated certain contractual triggers for the application of fallbacks. ISDA has confirmed that it constitutes an "Index Cessation Event" for the purposes of the ISDA IBOR Fallbacks Supplement and the ISDA 2020 IBOR Fallbacks Protocol for all 35 LIBOR settings on the basis that all LIBOR settings will either permanently cease to be published or become non-representative from the dates specified in the FCA's announcement.

1 https://www.fca.org.uk/news/press-releases/announcements-end-libor

Other milestones:

LIBOR is a set of benchmark rates that are forward-looking and published in 7 tenors. This setup allows the parties to calculate the interest payable for a specific period at the start of that interest rate period itself.

On the other hand, RFRs are backward-looking overnight rates (as of Mar. 2021, none of the Regulators have endorsed any term rates for RFRs). This means that on every RFR Banking Day, a new rate will be published. These daily RFRs are compounded in arrears to arrive at an effective interest rate for a given period. Hence, for RFR-linked facilities, the banks will not be able to determine the interest rates until the end of the interest rate period.

To allow the banks to calculate the payable interest and generate interest payment notices prior to the due date, a lag period will be introduced between the interest rate period and the cashflow period. The expected market convention for this lag is a 5 RFR Banking Day (5 BD) lookback.

LIBORs and RFRs are economically different. Hence, an interest rate comprising of “LIBOR + Client Margin” is not equal to “Compounded RFR + Client Margin”. For transactions to transition away from term rates such as LIBOR to rates based on RFRs (which are near risk-free), a Credit Adjustment Spread (CAS) will be used as the means of addressing the issue of potential transfer of economic value from one party to another as a result in a change of Reference Rate. (Source: LMA Commentary). An important point to note is that for all transitioning facilities, the client margin remains unchanged.

Therefore, the quotation of the interest rates for transitioning facilities would move from “LIBOR + Margin” to “RFR + CAS + Margin”.

ISDA conducted a Market Survey on the preferred transition spread adjustment methodologies. The transition spread will determine the tenor-based X, which will be added to the RFR, when transitioning from LIBOR to RFR.

The transition adjustment spread will be based on the difference between LIBOR and the RFR derived rate that is calculated using a median over a five-year lookback period prior to the fallback activation date.

The historical median approach derives a single value for the transition spread (Refer to the yellow line on the graph).

The transition spread will be calculated and published for each LIBOR tenor based on the historical differences between LIBOR for that tenor and the compounded RFR over the relevant tenor. This will differ the credit spreads across different tenors.

Bloomberg Index Services Limited (“Bloomberg”) is responsible for calculating and publishing the spread adjustment. The spread has been calculated using a historical median approach over a five-year lookback period from the date of the FCA's LIBOR announcement (on 5 March 2021). Since July 2020, Bloomberg has been publishing the spreads, compounded RFRs and the all-in fallback rates (compounded RFR + spread). For more information, please visit: Bloomberg Begins Publishing Calculations Related to IBOR Fallbacks). The 5Y median spreads are also publicly available on a delayed basis – click here for more information . The FCA's LIBOR announcement on 5 March 2021 triggered the fixing of the spread adjustments. Consequently, the spread adjustment for all 35 LIBOR settings is now fixed and will not be subject to further change.

While using the 5Y median approach is one of the options available to calculate the credit spread adjustment, different regulators have agreed that this adjustment is a “commercial agreement” and hence, FAB may adopt alternative methodologies / formulae to compute the spread adjustment.

Contracts referencing SOFR are usually based on the average/compounding of daily interest rates over a given period of time. SOFR compounded/averaged rates are quite smooth and can be easily referenced in financial contracts, as demonstrated by the growing use of SOFR in futures, swaps and floating-rate notes (FRN). SOFR futures and OIS, and the many SOFR floating-rate notes that have been issued, all use either a compound or linear average of SOFR over a fixed period of time as the floating-rate paid under the terms of the contract, not a single day’s realization of SOFR. (Source: ARRC FAQs)

In January 2020, the Bank of England Working Group on Sterling Risk-Free Rates (UK RFR WG) set up a Term Rate Use Case Task Force (the “Task Force”) to provide guidance on the need for the potential usage of Term SONIA Reference Rates. Post their analysis, the Task Force concluded that the use for SONIA compounded in arrears was operationally achievable for 90% by value of the Sterling Libor loan market sampled and that the remaining 10% by total loan value would likely require alternative rates.

These alternative rates could be fixed rates, the Bank of England Base Rate or a SONIA term rate (if and when available). To assess the necessity of the usage of SONIA term rates, the Task Force laid out the following criteria:

• Structure and characteristics of the product; and
• Operational capability and the sophistication of the borrower or end-user.

The findings of the Task Force acknowledged the need for term rates or equivalents for 3 product classes:

(1) Trade & Working Capital Products (including discounting/letters of credit, supply chain finance, etc.);

(2) Export Finance & Lending in Emerging Markets; and (3) Islamic Finance. Please see the conclusion of the findings of the Task Force in the table below (Source: BoE Use Cases of Benchmark Rates: Compounded in Arrears, Term Rate and Further Alternatives)

As of March 2021, regulator-endorsed Term RFRs are not yet available. For SONIA, the administrator for the term rates has not yet been finalised. For SOFR, there is no certainty on the status of the availability at the associated timelines for Term SOFR.

The FCA, in its Conduct Risk during LIBOR Transition Q&As states that “counterparties less familiar with interest rate markets may have a better understanding of Bank Rate, the Bank of England’s monetary policy rate, than of SONIA” (Source: FCA Conduct Risk During LIBOR Q&As). Hence, FAB may offer Bank of England Base Rate instead of SONIA for some products (including some regulated mortgages offered by its branch in the United Kingdom).

As noted by the FCA, “the relationship between Bank rate and SONIA has been fairly stable over recent years, with movements in SONIA being highly correlated with Bank Rate (which has tended to be a few basis points higher than SONIA)”. Therefore, the credit adjustment spreads used for transactions on a “Base Rate + Spread” setup may not be the same as for those on a “SONIA + Spread” setup.

Pertaining to question 3.6, FAB is monitoring the market closely for updates on the term rates for RFRs and their usage for the 3 product classes mentioned (trade & working capital products, export finance & lending in emerging markets and Islamic finance).

The UK FCA will not compel the current LIBOR panel banks to contribute submissions for LIBOR calculation beyond 31 December 2021. The FCA has also announced the cessation and loss of representativeness dates for LIBOR (see question 2.3). In a scenario where IBORs cease to exist, interest rates and other parameters related to the specific product may be determined based on the Terms and Conditions (T&Cs) pertaining to the permanent cessation of IBOR noted in the Contract. In the absence of such T&Cs, FAB intends to follow applicable regulatory and industry guidelines and attain mutual agreement when replacing IBORs.

Fallback language refers to the legal provisions in a contract that apply if the underlying reference rate in the product (e.g. LIBOR), is discontinued or is unavailable. The FSB’s Official Sector Steering Group (OSSG) has recommended that market participants both understand their contractual fallback arrangements and ensure that those arrangements are robust enough to prevent potentially serious market disruptions in a LIBOR cessation event. Fallback language typically involves 3 main components: trigger, benchmark replacement and benchmark adjustment spread. The triggers define scenarios that allow the fallback language to come into effect. Benchmark replacement defines the rates that the facility falls back on. Benchmark adjustment spread defines the methodology / formula / terms / fixed credit adjustment spread between the outgoing (L)IBOR and the incoming RFR.

The CCPs will adopt the ISDA fallbacks in relation to cleared interest rate derivatives, but CCPs do have discretion in the matter.

ISDA has provided the following explanation:

CCPs that clear over the counter (OTC) interest rate derivatives generally incorporate the 2006 ISDA Definitions. Therefore, once the relevant rate options are amended (by ISDA), to include triggers and fallbacks, these triggers and fallbacks would generally apply to OTC derivatives subsequently cleared at such CCPs. However, LCH and CME have confirmed that they may use the discretion they have in their rulebooks to implement the amended rate options (i.e. the rate options with the index cessation event trigger and fallbacks), in existing transactions that they have cleared.

(Source: ISDA – Consultation on pre-cessation issues for LIBOR and certain other IBORs)