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 Alternative Reference Rates (ARRs) and where suitable, encouraging derivative market participants to transition new contracts to an appropriate ARR.

This is often referred to as a ‘multi-rate approach’ – where a new ARR is developed alongside maintaining an IBOR. Since 2014, the work has been coordinated at an international level by the FSB’s Official Sector Steering Group (OSSG).

In July 2016, the OSSG formally launched a third major initiative, to improve contract robustness to address the risks of discontinuing widely used interest rate benchmarks. The OSSG invited ISDA to lead this work as it pertained to derivative contracts, which are the largest source of exposure to the IBORs. Although all of the major IBORs have been strengthened since the OSSG was formed, FSB member authorities in certain jurisdictions have moved away from their original view that a ‘multi-rate’ approach, in which each IBOR could be made sustainable and potentially coexist with the Alternative Reference Rate (ARR) was possible.

(Source: Financial Stability Board report on ‘Reforming major interest rate benchmarks, 2019’; Bank of England, 2017)

LIBOR is a benchmark rate produced for five currencies, each with seven maturities, which include overnight/spot, 1-week, 1-month, 2-month, 3-month, 6-month and 12-month, producing 35 rates per London business day. It is a wholesale funding rate that is anchored in the LIBOR panel banks’ unsecured wholesale transactions. LIBOR’s administrator, the Intercontinental Exchange maintains a reference panel of between 11 and 16 contributor banks for each currency calculated – GBP, USD, EUR, CHF and JPY.

The major interest reference rates (such as LIBOR, EURIBOR and TIBOR), have been widely used in the global financial system as benchmarks for a large volume and broad range of financial products and contracts.

The cases of attempted market manipulation and false reporting of global reference rates, together with the post-crisis decline of liquidity in the interbank unsecured funding markets, have undermined confidence in the reliability and robustness of existing interbank benchmark interest rates. Uncertainty surrounding the integrity of these reference rates represents a potentially serious source of vulnerability and systemic risk.

This resulted in suggesting the development of ARRs that are more closely related to certain financial transactions (such as derivative contracts).

(Source: Financial Stability Board report on ‘Reforming major interest rate benchmarks, 2014’)

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

Although the adoption of an ARR is voluntary, the heightened risk of discontinuation of LIBOR after the end of 2021 makes it essential that market participants consider moving to ARRs 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 ARRs before LIBOR ceases to exist.

(Source: ARRC)

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 ARR 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 there is an appreciable risk that LIBOR will end, once the support of the competent authorities for the benchmarks ends at end-2021. There is also the risk that LIBOR could no longer be found representative of the underlying market it purports to measure, due to a lack of underlying transactions.

(Source: Financial Stability Board report on ‘Reforming major interest rate benchmarks, 2019’)

Each of the Central Bank-led ARR working groups that were set up at the recommendation of the Financial Stability Board (FSB) have established specific websites to provide market participants with information regarding key transition topics and steps, meeting minutes, feedback on consultations, and other relevant data.

Currency	Working Groups Links
GBP	www.bankofengland.co.uk
EUR	www.ecb.europa.eu
USD	www.newyorkfed.org
JPY	www.boj.or.jp
CHF	www.snb.ch
SGD	www.abs.org.sg
HKD	www.hkma.gov.hk

In addition, industry bodies representing key stakeholders affected by the LIBOR transition have also produced considerable material which is available on their respective websites.

Industry Body	Industry Body Links
ISDA International Swaps and Derivatives Association	www.isda.org
ICMA International Capital Market Association	www.icmagroup.org
LMA Loan Market Association	www.lma.eu.com
LSTA Loan Syndications and Trading Association	www.lsta.org
APLMA Asia Pacific Loan Market Association	www.aplma.com
ACT Association of Corporate Treasurers	www.treasurers.org

The Bank 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.

Working Groups in each jurisdiction have recommended robust ARRs to transition away from existing IBORs. The ARR benchmarks are overnight, whereas the current use of IBORs is largely in term rates.

The adoption of liquidity in ARRs 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 ARRs will be accelerated by the adoption of SOFR and ESTR discounting by clearing houses.

In addition, ISDA intends to publish a supplement amending the 2006 ISDA definitions to incorporate new benchmark ‘fallbacks’. 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 ARRs.

Regulators and Central Banks have provided guidance on timelines for the IBOR transition, including various milestones they would expect banks to meet. Some of the key milestones are summarised below:

Currency	Timeline
GBP	March 31, 2021: Cease issuance of any new GBP LIBOR linked cash products and linear derivatives (*For further details on LIBOR transition milestones in the UK, please see here)
USD	June 30, 2021: Cease issuance of any new USD LIBOR linked business loans and derivatives
HKMA*	June 30, 2021: Cease issuance of any new LIBOR linked products (*For further details on LIBOR in Hong Kong please see here)

For LIBOR transactions, the interest rate is known upfront, while, when transacting in ARRs, the interest cost will only be known at the end of the interest period – by compounding the daily ARR over the interest period. In certain settings, the cost might be known as ‘n’ days prior to the end of the interest period.

LIBORs comprise of 3 components: credit risk (AA banks), liquidity tenor adjustment and the credit risk free component. Since the ARRs are overnight, they only contain the credit risk free component. Hence, a credit spread adjustment is required to compensate for the credit risk and liquidity tenor components in-built in LIBOR.

For transactions to transition away from term rates such as LIBOR to rates based on ARRs (which are near risk-free), a credit spread adjustment 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)

Therefore, the quotation of the interest rates for transitioning facilities would move from LIBOR + Margin to ARR + Credit Spread Adjustment + Margin.

ISDA, at the request of the FCA and FSA, 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 ARR, when transitioning from LIBOR to ARR.

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

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, the Bank may adopt alternative methodologies / formulae to compute the spread adjustment.

In the SOFR market, both, average and compounded coupons have been used, whilst the SONIA market has been using compounded coupons. There are different ways in which a market participant can achieve some degree of cashflow certainty before an interest payment is due. One approach is to ‘lag’ the rate reference period by 5 business days in order to establish a 5day cashflow certainty.



An alternative approach would be to use the lock-out mechanism, which repeats one of the daily rates for the final few days of the calculation. There are different options for applying a margin to a product using a compounded rate. The margin could be added to the daily rate that is compounded or it could be added to the compounded rate at the end of the compounding period, the latter is used in the derivatives (OIS) market.

(Source: BOE Discussion Paper; BOE Statement)

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)

The FCA will not compel the panel bank to contribute interest rates for IBOR calculation beyond 31 December, 2021. This arrangement may result in the permanent cessation of IBOR. 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, the Bank intends to follow applicable regulatory 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 ARR.

Yes, the same fallback rate will apply to all tenors of a particular IBOR, even though the fallback rates are overnight rates and the IBORs have a variety of terms. However, to account for the move from a ‘term’ rate (i.e. the IBOR), to an overnight rate (i.e. the overnight ARR), the fallbacks ISDA implements will apply an adjustment to the relevant overnight ARR so that it is more comparable to the relevant IBOR. The consultation refers to the adjusted rate as the ‘adjusted ARR and asks for feedback on the best approach for calculating the adjusted ARR.

(Source: ISDA – IBOR Fallbacks for 2006 ISDA Definitions – FAQs)

At some point after January 1, 2022, but prior to LIBOR disappearing, the FCA, as LIBOR’s regulator, may announce that it no longer considers the relevant rate capable of being ‘representative’. Therefore, there might be a timing difference between regulators announcing the unrepresentativeness of a rate and its cessation. The FCA is mindful that contracts could therefore choose to include a trigger (pre-cessation), based on such an announcement.

The NY Fed’s ARRC has proposed the inclusion of such a ‘pre-cessation trigger’ in cash market fallbacks, and for derivative contracts that reference LIBOR only, a pre-cessation would apply.

(Source: FCA)

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)

“ISDA has delayed the expected effective date for its fallback protocol until mid- to late-January. In a letter to regulators on 21 September, the trade association said the timetable is contingent on receipt of a positive business review letter from the US DoJ and the finalisation of work with competition authorities in other jurisdictions. Once the officials have provided the necessary documentation, ISDA plans to announce the official launch and provide market participants about two weeks’ notice, during which time they will be able to commit to the protocol in escrow.”

(Source: www.isda.org)

The Bank of England recommends the use of a ‘replacement of screen rate clause’ as mentioned by Loan Market Association (LMA). The clause applies where a replacement (or benchmark) rate is contemplated and facilitates amendments to be made so as to incorporate the use of that benchmark rate into the documentation as and when the screen rate replacement event occurs.

LMA has also published exposure drafts with the insertion of “Rate Switch Agreements” to facilitate the transition of current LIBOR referencing facilities to ARRs. However, it is important to note that exposure drafts are open to market review and are prone to being modified. Hence, fallback / contractual language suggested by LMA is constantly developing.

The NY Fed’s ARRC has proposed fallbacks for loans (both bi-lateral and syndicated), securitizations, private student loans, adjustable rate mortgages and floating rate notes. The ARRC’s proposals typically involve a waterfall that includes the use of a term rate, or otherwise a backward-looking compounded/daily rate if a term rate is not available. The ARRC has also aligned itself with ISDA in terms of the selection of the spread adjustment. The ARRC will use the same value as computed for ISDA as the selected spread adjustment.

For more information on ARRC’s fallback recommendations for bilateral loans, click here. For more information on ARRC’s fallback recommendations for syndicate loans, click here.

Please note that the above fallback language templates/drafts are available in the market. These options may or may not be adopted by FAB, and by providing this information FAB is not recommending particular fallback positions to customers.

IBOR transition working groups have released statements acknowledging that COVID-19 will cause delays for the IBOR transition in loan markets. However, the cessation date for the use of IBORs by end-2021 has not changed.

(Source: Statement from the Risk-Free Rate Working Group on the impact of COVID-19)

In September 2019, the International Accounting Standards Board (IASB), amended some of the requirements for hedge accounting. The amendments modify some specific hedge accounting requirements to provide relief from potential effects of the uncertainty caused by the IBOR reform. The amendments came into effect on 1 January, 2020.

These changes provide temporary relief for so-called ‘hedge relationships’ prior to LIBOR’s discontinuance (‘Phase 1’), further guidance relating to the actual adoption of ARRs and the discontinuance of LIBOR (Phase 2) that was provided earlier this year.

In March 2020, the Financial Accounting Standards Board (FASB) also approved an Accounting Standards Update (ASU) to provide ‘temporary, optional guidance to ease the potential burden in accounting for reference rate reform’.