By the end of 2021, the London Interbank Offered Rate (LIBOR), which has been the world’s most widely used benchmark interest rate, is due to be phased out completely, as markets make the transition to LIBOR alternatives.
As part of the ongoing international and national regulatory discussions and proposals to reform the LIBOR, regulators around the globe have emphasised that market participants should move from LIBOR to Alternative Reference Rates (ARRs). Some of these reforms are already effective, whilst others are yet to be implemented. These reforms may cause such benchmarks to perform differently compared to the past, or to be discontinued.
AUB recognises the importance and impact the transition will have on our clients through the products and services we offer. Consequently, AUB has established a group-wide LIBOR Transition Project to prepare for the discontinuation of LIBOR and assist our clients in navigating the various challenges arising from the transition.
LIBOR is a set of benchmark interest rates that provide an indication of the average rates at which panel banks can borrow in the interbank market. 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). LIBOR also provides the basis for determining the rates applied to a variety of financial instruments, including corporate loans, bonds, derivatives and other financial transactions across the world.
Since the 2008-09 financial crisis, the decline in liquidity in interbank unsecured funding, the absence of a sufficient number of underlying transactions, and historical cases of attempted market manipulation undermined confidence in the reliability and robustness of the existing LIBOR.
The use of ‘expert judgement’ and the uncertainty surrounding the integrity of the computation of LIBOR have prompted a major review by the Financial Stability Board (FSB). In July 2017, the UK Financial Conduct Authority stated that they will no longer compel panel banks to contribute quotations for LIBOR.
Regulators, market participants and industry bodies have put in a significant amount of effort to develop replacements that meet regulatory requirements. The outcome is a set of alternative rates based on overnight transactions that are designed to be representative of a risk-free rate.
Overnight Alternative Reference Rates (ARRs) have been identified as replacements for each LIBOR currency. Below is an overview of the recommended alternative rates for LIBOR currencies.
|USD||SOFR (Secured Overnight Financing Rate)||Federal Reserve Bank of New York (FED)||Secured|
|EUR||ESTR (Euro Short-Term Rate)||European Central Bank (ECB)||Unsecured|
|GBP||SONIA (Sterling Overnight Index Average)||Bank of England (BoE)||Unsecured|
|CHF||SARON (Swiss Average Rate Overnight)||SIX Swiss Exchange||Secured|
|JPY||TONAR (Tokyo Overnight Average Rate)||Bank of Japan (BOJ)||Unsecured|
The Alternative Reference Rates Committee (ARRC) of the United States, comprised of a group of Regulators and Federal Boards, was formed to identify an alternative reference rate to USD LIBOR, based on transactions from a reliable underlying market.
ARRC was also tasked with preparing a plan to facilitate the acceptance and use of the selected Alternative Reference Rate (ARR) and a robust contract design.
Following more than two years of review and market consultation, in 2017, the ARRC selected the Secured Overnight Financing Rate (SOFR) as the preferred alternative to USD LIBOR and as the reference rate for use in financial contracts and USD derivatives.
Below are key differences between LIBOR and ARRs:
|Forward-looking rate with the defined tenors||Overnight only (as of now) Backward-looking rates with limited forward term structure|
|Based on expectations and quotes submitted by panel banks instead of actual transactions||Based on actual transactions|
|Includes a built-in Credit Risk and Liquidity Spread across tenors||Nearly Risk-Free Rates|
|Centrally calculated in the London Interbank Market||Each jurisdiction has its own rate calculation mechanism|
|Responsive to risk-free rates, liquidity and credit pricing (especially in the event of stress)||Responsive to the change in risk-free rates|
On 4 December 2020, the ICE Benchmark Association (IBA) launched a consultation intended to provide market participants with details on its intention to cease the publication of LIBOR settings starting from the following proposed dates:
|31 December 2021||GBP, EUR, CHF, JPY||All tenors|
|31 December 2021||USD||One-week and two-month tenors|
|30 June 2023||USD||Overnight, one-, three-, six- and twelve-month tenors|
Clients now have less than a year to review and renegotiate commercial contracts and facility agreements that mature after 2021.
Clients will need to consider the implications arising from these staggered cessation dates. The extended timeline for certain USD LIBOR Tenors was introduced to support a smooth transition to ARR.
Regulators have recommended that market participants continue to actively transition away from LIBOR to ARR as fast as possible and no later than 31 December 2021 for new transactions. Where applicable, market participants may also need to carefully consider the potential impact on accounting, hedging and corporate earnings, and may need to upgrade their systems to support multiple benchmark rates.
The IBA consultation is not, and must not be taken to be, an announcement that IBA will cease or continue the provision of any LIBOR settings after 31 December 2021 or 30 June 2023.
The transition from LIBOR to ARR will have an impact on the products, businesses, systems and processes used by banks, clients and various counterparties.
LIBOR has been used extensively across a range of business processes, including accounting, valuation, hedging, risk and financial modelling in many industries. Accordingly, clients may consider conducting a business-wide risk assessment to identify all the issues that need to be addressed pertaining to the LIBOR transition.
Potential Areas of Impact for Clients:
|Products||• Loans: All types of Foreign Currency (USD, GBP, EUR, JPY, CHF) Loans, including but not limited to: Bilateral, Syndicated, Real Estate and Floating rate loans
• Derivatives: Interest Rate Swaps
• Liabilities: LIBOR-linked deposits and call accounts
|Business Processes/Systems||• Working Capital Management – Cash Flow Forecasting
• Risk Management (Currencies, Interest Rates)
• Hedge Accounting
• ERP & Treasury Systems
• Treasury Management System
|Review and Remediation||• Credit Facility Agreements
• ISDA Agreements
• Facility confirmation letters, Terms and Agreements
• LMA Syndication agreements
• All other types of financial Contracts as applicable
• Clients’ internal policies, such as investment, borrowing, policies and intercompany agreements
• Service Agreements with vendors and system solution providers
Firms may consider analysing their facility and commercial contracts by currency and tenor to identify the impacted USD LIBOR transactions. Based on the IBA consultation, the extension of USD LIBOR will likely allow USD LIBOR contracts maturing prior to July 2023 to expire without the need for remediation. Clients with USD LIBOR exposures maturing beyond June 2023 are still required to remediate their contracts, as per the existing timetables.
Following the conclusion of the IBA consultation, the cessation announcements of all tenors of USD, GBP, JPY, CHF and EUR LIBOR settings could trigger the calculation of spread adjustments with a fixing on that announcement date for all of the LIBOR settings.
Credit Adjustment Spread:
LIBOR and RFRs are calculated using separate methodologies and therefore there may be differences between the published rates of the two benchmarks. In order to accommodate the differences observed and minimize value transfer to the extent possible, industry working groups recommend the usage of a credit spread adjustment. The established market approach for the credit spread adjustment will be based on the historical median with 5-year lookback period that calculates the difference between LIBOR and the alternative reference rate over five years’ worth of daily data points. It is proposed that the median of those differences be added to the alternative reference rate when fallback language is activated.
The spread adjustment calculation as recommended by ISDA, the SRFRWG for cash products and the ARRC for cash products will be based on a historical median with 5-year lookback approach and will be calculated on the date of a public statement by the regulator or administrator of LIBOR that triggers either the permanent or pre-cessation triggers (whichever occurs first) even if the statement is forward-looking.
For more information, consultations raised on this topic by the ISDA and ARRC can be found below:
Clients are advised to monitor the outcome of the IBA consultation to determine the next steps as regards these contracts.
To facilitate the transition to alternative reference rates for derivatives, the International Swaps and Derivatives Association (ISDA) launched its IBOR Fallbacks Protocol and IBOR Fallback Supplement to amend fallbacks in legacy and new derivatives, effective 25 January 2021.
AUB is compliant with the ISDA 2020 IBOR Fallbacks Protocol as of 17 January 2021.
The Bank has launched a comprehensive LIBOR Transition Programme to take into account all the possible outcomes of the transition and ensure its seamlessness. The Programme enjoys the full commitment and support of AUB’s Board and Senior Leadership.
AUB Group’s geographical footprint and multi-jurisdictional nature of the transition add to the scale and complexity of implementation. Consequently, the Transition Programme’s scope covers all AUB Group’s entities, businesses and support units.
AUB recognises the importance and impact the transition will have on our clients through the products and services we offer.
Therefore, AUB is working towards adapting our products, systems and people to transition to the use of ARRs while simultaneously developing and implementing plans to mitigate the risks associated with the IBOR discontinuation.
To assist our clients throughout the transition, we are also evaluating the existing contracts across all products to determine the impact of the discontinuation of LIBOR or other benchmarks, and to address the potential changes to those contracts. The Bank is in the process of reaching out to clients with LIBOR-linked products to communicate the next steps and discuss transition options.
The Bank is also actively involved in discussions and transition efforts with regulators, industry bodies, trade associations and individual market participants. AUB is compliant to the ISDA 2020 IBOR Fallbacks Protocol as of 17 January 2021. The Bank is reaching out to its clients to understand their position regarding adherence to the Protocol and next steps if bilateral negotiations are preferred.
We are aware that the transition to ARRs is at different stages depending on jurisdiction, and is moving at different speeds. This also applies to the potential development of ARR-based term rates. AUB is continuously monitoring the ongoing developments pertaining to the transition and will continue to reach out and provide updates on key developments to our clients.
The Bank will allow any LIBOR-linked contracts expiring prior to their respective benchmark discontinuation date to mature without any amendments. However, for clients with LIBOR-linked contracts maturing after their expected cessation date, AUB will reach out to support said clients in transitioning to an Alternative Reference Rate in due course.
For clients with contracts linked to other IBOR currencies from the region, the Bank does not foresee any imminent changes to their agreements in the near future. Nonetheless, AUB will keep all clients updated as regards any changes imposed by the regulators in the upcoming period.
In the meantime, clients are not required to take any action at this point. However, feel free to contact your Relationship Manager who will be happy to address any queries that you may have regarding the LIBOR Transition.
For further information in relation to the LIBOR Transition, including expected timeframes, please refer to the below for details on the relevant LIBOR transition working group:
|LIBOR||Relevant Transition Working Group||Website|
|Sterling LIBOR||Bank of England and FCA Working Group||www.bankofengland.co.uk|
|US Dollar LIBOR||Federal Reserve Alternative Reference Rates Committee||www.newyorkfed.org|
|EURIBOR and EONIA||European Central Bank Working Group||www.ecb.europa.eu|
|JPY LIBOR and JPY TIBOR||Bank of Japan cross-industry committee on Japanese yen interest rate benchmarks||www.boj.or.jp|
|CHF LIBOR||Swiss National Bank working group on Swiss franc reference rates||www.snb.ch|
The information contained in the IBOR Transition document herein (the “Document”) or subsequently provided to customers(s), whether verbally or in documentary or any other form by or on behalf of AUB Group or any of its employees or advisors, is provided to customer(s) on the terms and conditions set out in this Document and such other applicable terms and conditions in individual agreements, parallel processes or general terms and conditions in an electronic, digital or physical form. This Document is not an agreement and is neither an offer nor invitation by the AUB Group to the customers to enter any agreement or form an opinion or take a decision in any shape or form. The purpose of this Document is to update the customers and interested parties and provide them with information that may be useful to them in making their financial decision in the future when required to do so. This Document includes statements, which reflect various assumptions and assessments arrived at by the AUB Group in relation to the subject. Such assumptions, assessments and statements do not purport to contain all the information that each customer may require. This Document may not be appropriate for all persons, and it is not possible for the AUB Group, its employees or advisors to consider the particular needs of each party who has access to or uses this Document. The assumptions, assessments, statements and information contained herein, may not be complete, accurate, adequate or correct. Each customer should, therefore, conduct its own investigations and analysis and should check the accuracy, adequacy, correctness, reliability and completeness of the assumptions, assessments, statements and information contained herein and obtain independent advice from appropriate sources. AUB Group, its employees and advisors make no representation or warranty and shall have no liability to any person under any law, statute, rules or regulations or tort, principles of restitution or unjust enrichment or otherwise for any loss, damages, cost or expense which may arise from or be incurred or suffered on account of anything contained in this Document or otherwise, including the accuracy, adequacy, correctness, completeness or reliability of the Document and any assessment, assumption, statement or information contained therein or deemed to form part of this Document. The AUB Group also accepts no liability of any nature whether resulting from negligence or otherwise howsoever caused arising from reliance of any customer upon the statements contained herein. The AUB Group may in its absolute discretion, but without being under any obligation to do so, update, amend or supplement the information, assessment or assumptions contained herein.