LIBOR discontinuation
The London Interbank Offered Rate (“LIBOR”) is a global interest rate benchmark which is used widely across a number of financial products including derivatives, bonds, loans, securitisations, deposits, as well as for banks' and other financial institutions’ own funding and capital needs. LIBOR provides an indication of the average rate at which each LIBOR panel bank can borrow unsecured funds in the London interbank market for a given period, in a given currency. The average is published and used by the financial markets. LIBOR is currently published across five currencies (Sterling, US Dollar, Euro, Swiss Franc and Japanese Yen) and across seven maturities (ranging from overnight to 12 months).
The Financial Conduct Authority (FCA) has stated that it will no longer compel LIBOR panel banks to submit LIBOR quotes beyond the end of 2021. This is because, in its opinion, (i) the underlying market that LIBOR measures is no longer liquid, and (ii) when a LIBOR panel bank submits a quote, such quote includes a term bank credit component, which is not necessarily appropriate for calculating interest amounts across various products. As a result of the statements made by the FCA, it is anticipated that from the end of 2021 LIBOR rates will cease to be published.
Across the financial services industry there is significant work being undertaken to develop rates which will be used as alternative reference rates across global financial markets.
Replacing LIBOR with Risk Free Rates
Risk free rates (RFRs) are seen as a more transparent replacement of LIBOR, because they are anchored in active, liquid underlying markets. RFRs are calculated on a different basis and are not like-for-like replacements for LIBOR.
Major differences between LIBOR and RFRs:
- RFRs are overnight rates which are backward-looking i.e. they are based on actual transactions that have taken place on the business day before, whereas LIBOR is forward-looking and is published in relation to a future term.
- LIBOR is currently published in five currencies, whereas RFRs are specific to each currency and may be calculated using different methods.
- RFRs do not include a forward-looking term bank credit risk component.
- Administration of the LIBOR rate is currently undertaken by the ICE Benchmark Administration (IBA), whereas RFRs are and will be generally administrated by central banks/federal banks. SONIA for example is administered by the Bank of England.
- Publication of LIBOR currently occurs around 11.45 each day and may only be published by the IBA and their partners. Whereas SONIA is published at 09.00 on the following business day in London via the Bank of England’s Interactive Statistical Database.
Recommendations
Several regulatory and trade body working groups have been established to assess and select alternative RFRs across all major currencies; the Bank of England Working Group on the Sterling RFR has reviewed several options and recommended the Sterling Overnight Indexed Average rate (SONIA) as its preferred benchmark rate. SONIA is an overnight rate, set in arrears and based on actual transactions in overnight indexed swaps for unsecured transactions in the Sterling market. This rate is already used in the derivatives markets and there are a growing number of bonds also using it.
In the US, the Alternative Reference Rate Committee (ARRC) has recommended the Secured Overnight Financing Rate (SOFR) as its preferred replacement benchmark rate.
Term v. RFRs
Term rates, such as LIBOR, provide borrowers with a known interest rate for the period of borrowing and allowing calculations of interest to be made at the start of the interest period. This is not possible currently with RFRs such as SONIA.
There is on-going financial services industry discussion about the possibility of creating a forward-looking “term SONIA” rate. However, the situations where such a rate may be preferable, the methodology for its creation, and the timing of its introduction, all remain uncertain. The advice from the FCA is that UK regulated firms should not wait for, or rely on, the development of any potential term SONIA rate.
The requirement for a Term SOFR is also being considered by the USD-denominated industry and the ARRC in the US.
Other IBORs – Transition
LIBOR is one of a number of Interbank Offered Rates (IBORs) that are widely used in the global financial markets. Work is also underway to replace other global IBORs.
LIBOR Transition at BACB
Here at BACB we have convened our own LIBOR Transition Working Group, comprised of key stakeholders from across the Bank, which has been working in partnership with the wider industry to ensure that the Bank is ready for the changes coming down the line. As part of its work the group has been monitoring regulatory announcements and guidance, and is in active discussion with external law firms and specialist advisers, as well as the Bank’s Treasury, Operations and IT teams to examine the possible impacts of the transition. As further developments happen we will be communicating directly with all our clients via their relationship managers to explain the changes being made to their existing products and services provided by the Bank, working with them to make certain that any disruption is minimised, and that we continue to be their preferred banking partner in specialist markets.
Should you have any queries specifically regarding this please contact us at: LIBOR@bacb.co.uk
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