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).
With the significant decrease in transactions in the unsecured interbank lending market since the Global Financial Crisis, LIBOR submissions have increasingly been based on judgements with little actual borrowing activity against which to validate their judgements. As a result, 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 regulatory statements made a number of LIBOR rates will cease to be published at the end of 2021. The most recent FCA statement can be found here: https://www.fca.org.uk/markets/libor-transition
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.
Risk free rates (RFRs) are seen as a more transparent replacement of LIBOR, because they are anchored in active, liquid underlying markets and based on actual transactions. With the basis in actual transactions, rather than judgement, RFRs are considered more representative of the true cost of funding in those markets. RFRs are calculated on a different basis and are not like-for-like replacements for LIBOR.
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 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. Therefore where transactions cannot use a rate that is based on a compounded in arrears methodology, such as discounting a letter of credit, a forward looking rate, may be determined as the preferred alternative.
One forward looking rate being considered to replace USD LIBOR is the Bloomberg Short-Term Bank Yield Index (BSBY). Unlike the SOFR this is not a risk-free-rate, and instead is comprised to represent a series of credit sensitive reference rates that incorporate systemic bank credit spreads and define a forward term structure. Similar to LIBOR, the BSBY index calculates overnight, 1-month, 3-month, 6-month and 12-month yields and publishes them daily at 8:00 am NYT.
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.
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.
BACB have prepared a download with further information on the LIBOR Transition, and the impact on the process for Real Estate Finance transactions.
Download LIBOR Transition Highlights 1.0 (PDF)
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Should you have any queries specifically regarding this please contact us at: LIBOR@bacb.co.uk
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