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Preparing for Transition from IBOR to Alternative Reference Rates
Interbank Offered Rates (“IBORs”), being the interest rate at which banks lend to and borrow from one another in the interbank market, are in the process of being reformed. There are a number of IBORs that are widely used in the financial markets including the London Interbank Offered Rate (“LIBOR”) and the Euro Interbank Offered Rate (“EURIBOR”).
LIBOR reformThe Financial Conduct Authority (the “FCA”) announced in 2017 that it will no longer seek to compel or persuade panel banks to submit the rates required to calculate the LIBOR after the end of 2021. The FCA have made it clear that all market participants need to have removed dependencies on LIBOR by this date and that it is now time for market participants to start transitioning from the use of LIBOR to alternative benchmark rates, if they are to avoid disruption when the publication of LIBOR ceases.
As yet, there is no market-wide consensus as to how the transition from LIBOR to alternative benchmarks will be managed or exactly what the alternative benchmarks will be. Investec Bank plc (and its subsidiaries) (together “Investec”) are currently working with the industry to ensure that the process is managed as smoothly as possible. One aspect of this is the on-going work to develop new Alternative Reference Rates ('ARRs') as a replacement for LIBOR.
While there are still many uncertainties regarding how the market’s transition to alternative reference rates will be implemented, these developments may have significant impacts on our clients and it is important that our customers understand what the transition entails and the actions they should consider taking to prepare their businesses. Over time, we will also be contacting customers directly to outline our intended approach to transition. In the first instance, we have set out here some key details regarding these changes. If you require any further information or have any questions or concerns relating to IBOR transition we would encourage you to contact your usual Investec contact.
What is LIBOR?The London Interbank Offered Rate (“LIBOR”) is a measure of the average rate at which banks are willing to borrow wholesale unsecured funds. It is calculated and published daily by the Intercontinental Exchange (ICE) Benchmark Administrator based on submissions from twenty selected panel banks. It is published in GBP (British Pound), USD (US Dollar), EUR (Euro), JPY (Japanese Yen) and CHF (Swiss Franc), and across a range of seven tenors (overnight/spot next, one week, one month, two months, three months, six months and 12 months).
It is one of the most widely referenced interest rate benchmarks, estimated to underpin $300tn ($30tn in GBP markets) of financial contracts including derivatives, bonds and loans.
Why does LIBOR need to be replaced?Since 2014, global financial regulatory authorities have expressed concerns about the reliability and robustness of existing interbank benchmark rates. In 2017, both the FCA and the Bank of England noted that it had become increasingly apparent that the absence of active underlying markets and the scarcity of term unsecured deposit transactions raised serious questions about the future sustainability of the LIBOR benchmarks. Without sufficient transaction data, LIBOR submissions made by banks to sustain the LIBOR rate are increasingly based on expert judgement of panel banks rather than actual transactions, which heightens the risk of benchmark manipulation. RFRs on the other hand are based on more liquid overnight lending markets.
The FCA received a voluntary agreement from the LIBOR panel banks to continue to submit to LIBOR until end-2021, to enable time for the market to transition away from LIBOR.
What IBORs are impacted and what are the replacement benchmarks?
Working Groups formed in the jurisdictions of the five key IBOR currencies have identified replacement RFRs as follows:
Alternative Reference Rates Committee
SOFR (Secured Overnight Financing Rate)
Federal Reserve Bank of New York
Secured rate that covers multiple overnight repo market segments
Working Group on Sterling Risk-Free Reference Rates
SONIA (Sterling Overnight indexed Average)
Bank of England
Unsecured rate that covers overnight wholesale deposit transactions
The National Working Group on CHF Referenced Rates
SARON (Swiss Average Rate Overnight)
Secured rate that reflects interest paid on interbank overnight repo rate
Study Group on Risk-Free Reference Rates
JPY LIBOR TIBOR
TONAR (Tokyo Overnight Average Rate)
Bank of Japan
Unsecured rate that captures overnight call rate markets
Working Group on Risk-Free Reference Rates for the Euro Area
€STR (Euro Short-Term Rate)
European Central Bank
Unsecured rate that captures overnight wholesale deposit transactionsThese replacement ARRs are published daily and are increasingly being used more extensively, particularly in both the derivatives and bond markets.
Other benchmark rates such as EURIBOR and AUD BBSW have been reformed or are in the process of being reformed and, as such, will continue to exist.
What is the difference between IBOR and ARRs?There are a number of differences between the alternative ARRs and IBORs:
- Each IBOR currency has its own distinct ARR and administrator.
- IBOR is a forward-looking term rate published for a range of tenors and at the beginning of the borrowing period. Conversely, ARRs are overnight rates (rather than term) published at the end of the borrowing period, and are therefore backward looking.
- IBOR includes both a term liquidity premium and a term bank credit risk spread (i.e. an additional amount to account for the risk that the borrowing bank may not be able to repay its debt). ARRs, as they are backward looking, overnight rates, do not include, or may have a reduced, term and credit premium.
- ARRs are based on a large number of overnight money market transactions, therefore the risks associated with expert judgement (see above) do not arise.
When will the transition take place?Regulators, industry working groups and market participants are working through the implications and complexities of the transition from IBOR to the alternative benchmark rates. This includes the potential development of forward-looking term rates for the alternative benchmarks and the calculation of periodic interest rates.
The pace of transition varies across products, jurisdictions and markets. For LIBOR, the picture is likely to become clearer through the beginning of 2020, prior to the planned discontinuance of LIBOR at the end of 2021 but firms are encouraged to transition to ARRs as soon as possible and not wait for final market solutions
What is the difference with EURIBOR?The EURO Interbank Offered Rate (“EURIBOR”) is a daily reference rate published by the European Money Markets Institute (“EMMI”). However, unlike other IBORs which are being discontinued, EURIBOR is being reformed in order to be compliant as a benchmark rate on an ongoing basis.
Reformed EURIBOR rates will be calculated on the basis of a hybrid methodology applied to the contributions from the panel banks.
What should users of EURIBOR do in light of the reforms?Users of EURIBOR are encouraged to consider the change in methodology (including the transition period) in the context of their particular requirements and to speak to their counterparties where appropriate.
Although EURIBOR will continue, any contracts that refer to EURIBOR will need to be checked to ensure that the EURIBOR benchmark rate they refer to is capable of being a reformed and adapted rate.
What does IBOR transition mean for customers?The transition to alternative interest rate benchmarks will impact a range of transactions and products. You should expect to be affected if you have a contract with Investec that is linked or may be linked to IBORs. This could include a floating rate loan, bond, deposit or derivative.
There are differences between IBORs and the proposed alternative interest rates and, as a result, the transition may have pricing, cashflow, accounting and operational implications for you and/or your business. The transition of existing IBOR based contracts to contracts referencing the alternative rates may involve the payment of a spread adjustment.
We will contact you in due course with details on our approach to the use of the alternative interest rate benchmarks, including when we will cease to offer legacy benchmark based products and how we will deal with existing legacy benchmark based transactions or products.
What is Investec doing to understand the potential impact on clients?Investec is working closely with its regulators, market participants and industry to make sure the transition is as smooth as possible for its clients.
What is Investec doing to mitigate the impact of any change for clients?Investec supports the market transition from IBORs and is committed to working closely with its clients to ensure they are aware of and understand the potential impacts.
Investec recognises the complexity and scale of the IBOR transformation programme and is developing a comprehensive internal IBOR transition project plan to manage the associated risks.
What should you do now?There are a number of potential steps that you may wish to take now:
- Review the latest industry information available on IBOR discontinuation
- Identify any transactions you have that are based on IBOR
- Evaluate the potential impacts that the move from IBOR to alternative benchmark rates may have on your business
- Consider seeking advice from your financial and/or legal advisers
Where can you find more information?More information on SONIA and LIBOR transition in the UK is available from the RFR Working Group: https://www.bankofengland.co.uk/markets/transition-to-sterling-risk-free-rates-from-libor
More information on EURIBOR reform is available from EMMI: https://www.emmi-benchmarks.eu/euribor-org/euribor-reform.html and from the Working Group on euro risk-free rates: https://www.ecb.europa.eu/paym/initiatives/interest_rate_benchmarks/WG_euro_risk-free_rates/html/index.en.html.
The websites of trade bodies also contain additional information including:
- LMA: https://www.lma.eu.com/libor
- ACT: https://www.treasurers.org/