Benchmark rate reform and transition to risk free rates - Mizuho Financial Group

Benchmark rate reform and transition to risk free rates
IBOR discontinuation and reform
Interbank Offered Rates (IBORs) are a series of benchmark interest rates, used globally for pricing
loans, debt securities and derivatives. Following recommendations made by the Financial Stability
Board in 2014, global initiatives have been undertaken to reform such benchmarks and to
commence the transition to alternative benchmark or reference rates.

Developments in the three major IBORs, as at 6th September 2021, are summarised below:

  Benchmark      Discontinuation / Reform measures

  LIBOR          The London Interbank Offered Rate (LIBOR) is a global interest rate benchmark
                 which is currently published across five currencies (Sterling, US Dollar, Euro, Swiss
                 Franc and Japanese Yen) and seven terms (ranging from overnight to 12 months).
                 On a number of occasions the Financial Conduct Authority (FCA) has stated that
                 markets should be prepared for announcements that some or all LIBOR rates will
                 cease after the end of 2021, or for the FCA to find that such rates are no longer
                 representative after the end of 2021.
                 On 5th March 2021, the FCA announced:

                 (1) immediately after December 31, 2021, publication of all seven euro LIBOR
                     settings, all seven Swiss franc LIBOR settings, the Spot Next, 1-week, 2-month
                     and 12-month Japanese yen LIBOR settings, the overnight, 1-week, 2-month
                     and 12-month sterling LIBOR settings, and the 1-week and 2-month US dollar
                     LIBOR settings will permanently cease;

                 (2) immediately after June 30, 2023, publication of the overnight and 12-month US
                     dollar LIBOR settings will permanently cease;

                 (3) immediately after December 31, 2021, the 1-month, 3-month and 6-month
                     sterling LIBOR settings will no longer be representative of the underlying market
                     and economic reality they are intended to measure and that representativeness
                     will not be restored and the FCA will consult on requiring IBA to continue to
                     publish these settings on a changed methodology (or ‘synthetic’) basis;

                 (4) immediately after December 31, 2021, the 1-month, 3-month and 6-month
                     Japanese yen LIBOR settings will no longer be representative of the underlying
                     market and economic reality they are intended to measure and that
                     representativeness will not be restored and the FCA will consult on requiring IBA
                     to continue to publish these settings on a synthetic basis for one additional year;
                     and

                 (5) immediately after June 30, 2023, the 1-month, 3-month and 6-month US dollar
                      LIBOR settings will cease to be provided or, subject to the FCA’s consideration
                      of the case, be provided on a synthetic basis and no longer be representative of
                      the underlying market and economic reality they are intended to measure and
                      that representativeness will not be restored.

EURIBOR        The Euro Interbank Offered Rate (EURIBOR) and the Euro Overnight Index Average
                 (EONIA) are the most important interest rate benchmarks within the Eurozone.
  EONIA
                 European interest rates are subject to the EU Benchmarks Regulation (BMR) which
                 was introduced in January 2018 to improve the integrity of, and set a common
                 framework for regulation of, benchmarks across the EU. The BMR set a deadline for
                 critical benchmarks to meet certain regulatory standards. The BMR transition period,
                 after which critical benchmarks failing to meet the standards cannot be used for new
                 contracts, has been extended to 31 December 2023.
                 In July 2019, European Money Markets Institute (EMMI) was authorised as
                 administrator of EURIBOR under the BMR and implementation of a new hybrid
                 methodology for EURIBOR was completed in November 2019.
                 EONIA will not be reformed and has been published in parallel with the Euro Short-
                 Term Rate (€STR) since publication of €STR began on 2 October 2019. EONIA will
                 be permanently discontinued on 3 January 2022.

  TIBOR          Reform measures were introduced in 2017 in respect of The Tokyo Interbank
                 Offered Rate (TIBOR), which is widely used as an interest rate benchmark for bank
                 loans in Japan. It is not proposed that TIBOR be discontinued.
                 Further reform may be undertaken, including the potential integration of Japanese
                 Yen TIBOR and Euroyen TIBOR (Japanese offshore markets).

Replacing certain IBORs with Risk Free Rates
Risk free rates ("RFRs") are generally proposed by the applicable working groups as replacements
or alternatives to IBORs, due to their transparency and limited exposure to manipulation. RFRs are
calculated on a different basis and are not like-for-like replacements for IBORs. RFRs are overnight
rates which traditionally are retrospective, i.e. they are published after the period to which they
relate, as opposed to IBORs, which are set at, or prior to, the commencement of the period to which
they relate. The differences between the two types of rate are discussed further below.

In preparation for the transition away from certain IBORs, authorities and industry working groups
have identified various RFRs as possible replacements for LIBOR and EONIA for each of the
currencies across which LIBORs are currently published:
   •   The Bank of England’s working group has recommended reformed Sterling Overnight Index
       Average (SONIA) as the preferred RFR alternative to Sterling LIBOR;
   •   The Federal Reserve Bank of New York, the European Central Bank, the SIX Swiss
       Exchange and the Bank of Japan have also established working groups to develop risk free
       rates to support the transition away from their respective currency LIBOR rates, and these
       rates have now also been selected (as set out in the table below); and
   •   In October 2019, the European Central Bank began publishing the Euro Short-Term Rate
       (€STR), a new unsecured overnight interest rate as an alternative to EONIA.

As at 6th September 2021, the development of each RFR is at a different stage and they vary in a
number of ways as highlighted in the table below.

Differences between IBORs and RFRs
As set out above, RFRs are described as ‘near risk free’ and are derived from actual transactions
that have taken place in the liquid underlying markets. There are a number of differences between
IBORs and RFRs which will need to be addressed in the transition process away from certain
IBORs, including:

   •   Credit and Liquidity Premiums: IBORs include the cost of bank credit risk and term
       liquidity risk, as they are based on the submissions of panel banks indicating where they
       can borrow unsecured funds in the relevant interbank market, whereas RFRs are based on
       overnight transactions. Transitioning existing contracts from IBORs to RFRs may involve
       incorporating a spread into the RFR to cover the lender’s funding costs and the credit risk
       premium of the borrower.

   •   Calculation direction: RFRs are backward looking overnight rates whereas IBORs are
       forward looking term rates, meaning that for IBORs the rate of interest is fixed and publicly
       available at the beginning of each interest period. Industry working groups have extensively
       analysed compounding RFRs in arrears and the Working Group on Sterling Risk-Free
       Reference Rates ("£RFR WG") has issued recommendations in this regard, which are
       discussed further below.

Points for you to consider in relation to IBOR transition
The FCA has clarified the timing of the cessation and non-representativeness of certain
benchmarks in its announcements on 5th March 2021, as described above. The £RFR WG has set
an end-Q3 2021 recommended milestone to complete active conversion of all legacy GBP LIBOR
contracts expiring after end 2021 where viable and, if not viable, ensure robust fallbacks are
adopted where possible. The changes brought about by such events may have an impact on
references to IBORs in existing products and may necessitate use of an alternative benchmark
rate, such as an RFR or an IBOR which is not being discontinued, or require fallback to a financial
institution's cost of funds.

Any such changes may impact the loans, debt securities and derivatives you currently hold (and
those you enter into in future), including:

   •   requiring the application of fallback provisions in the contract which provide for an
       alternative mechanism for calculating the relevant payment amount, such as when IBOR
       rates are not available, or the amendment of contracts to (i) replace existing fallback
       provisions with more robust fallback provisions, or (ii) to include fallback provisions;

   •   potential changes to the interest and other provisions of existing contracts, to provide for
       the transition to an alternative reference rate;

   •   the potential for a material mismatch between products in your portfolio (such as loans and
       corresponding hedges), which currently refer to the same benchmark rate;

   •   an impact on the value or pricing or cost to you of the product;

   •   potential accounting and tax issues, as many businesses use IBORs for derivative and
       other valuation purposes; and

   •   potential operational implications, such as changes to systems or processes (such as the
       impact on cashflow forecasting, when moving from forward looking to backward looking
       rates).

We recommend you keep up to date with the latest industry developments and consider whether
you require independent professional advice (whether legal, accountancy, tax or other advice) in
relation to IBOR transition and keep your position under review.

Next steps
Loans

The FCA announcement on 5th March 2021 confirmed that the following 26 LIBOR settings will
cease to be published from 31 December 2021.

     LIBOR                               Tenor
EUR LIBOR            all tenors
CHF LIBOR            all tenors
JPY LIBOR            spot next, 1 week, 2 month and 12 month
GBP LIBOR            overnight, 1 week, 2 month and 12 month
USD LIBOR            1 week and 2 month

The FCA announcement also confirmed that even if the remaining 9 LIBOR settings were to
continue to be published on a synthetic basis, they will no longer be representative of the underlying
market or economic reality that they are intended to measure.

      LIBOR                     Tenor
JPY LIBOR            1, 3 and 6 months
GBP LIBOR            1, 3 and 6 months
USD LIBOR            1, 3 and 6 months

Parties to facility agreements which contain any version of the LMA’s “Replacement of Screen Rate”
clause should consider whether the FCA announcement constitutes a “Screen Rate Replacement
Event” and whether they wish to begin the optional amendment process this clause offers in such
circumstances. Parties to facility agreements containing the LMA’s rate switch provisions in the
form of those in the LMA Recommended Forms (defined below) should consider whether the FCA
announcement constitutes a “Rate Switch Trigger Event” in their agreements. The £RFR WG
published a paper in August 2020 outlining how, by the end of Q3 2020, lenders should be in a
position to offer non-LIBOR linked products to borrowers and must include clear contractual
arrangements (through pre-agreed conversion terms or an agreed process for re-negotiation) in
new and re-financed sterling LIBOR loans to convert to alternative rates by year end-2021. In
compliance with these requirements Mizuho is able to offer non-LIBOR linked products and, where
relevant, will include clear contractual arrangements for conversion in in-scope agreements.

Also, in light of the recommended milestones set by the £RFR WG, from 1st April 2021 all new or
refinanced GBP lending entered into by Mizuho which expires after end 2021 has been and will
continue to be based on SONIA or other non-LIBOR alternatives.

In September 2020, the £RFR WG also recommended the use of a Five Banking Days Lookback
without Observation Shift as the standard approach for SONIA. A "Lookback" period allows for
payment certainty for borrowers when using an 'in arrears' rate such as SONIA, as the actual rate
is known to the borrower five days before interest is payable (rather than at the beginning of the
interest period, as with LIBOR). Although the £RFR WG has recommended a standard Lookback
period of five Business Days, the length of the Lookback period can be varied based on
borrower/lender needs.

In relation to syndicated loans, the Loan Market Association (LMA) has now published
recommended versions of its forms of facility agreement for loans referencing RFRs as part of its
library of recommended forms (the LMA Recommended Forms). The LMA Recommended Forms
(which were previously in circulation as exposure drafts) reflect the recommendations of the £RFR

WG and are being widely adopted by the loan market. The LMA Recommended Forms are being
used for both term and revolving loans (in sterling and other currencies) and are also being adapted
for use in bilateral transactions. In the majority of cases, the LMA Recommended Forms are being
adopted with minimal amendments, which indicates that lenders are becoming broadly comfortable
with the LMA’s approach. The publication of the LMA Recommended Forms occurred on 30 March
2021, just prior to the £RFR WG milestone for the cessation of new sterling LIBOR products on 1
April 2021.

The syndicated loan market does not have a protocol system (i.e. a multi-lateral method) for
amendments (such as that which is operated by ISDA) given the multilateral nature of syndicated
loans and so loan agreements referencing LIBOR may need to be individually amended to refer to
a replacement rate. On 25th October 2019 the LMA, to help streamline the amendment process,
published an exposure draft reference rate selection agreement for use in relation to legacy
transactions transitioning from LIBOR to an RFR. The LMA published this draft reference rate
selections agreement as a recommended form on 4 June 2021.

The Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal
Deposit Insurance Corporation have issued supervisory guidance encouraging banks to “cease
entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and
in any event by December 31, 2021”, noting that new USD LIBOR issuance after 2021 would
create safety and soundness risks. Foreign regulators have stated that they are considering
similar steps. The Loan Syndication and Trading Association has published a concept credit
agreement describing a term loan referencing daily simple SOFR or daily compounded SOFR
(using a "compound the balance" approach). Consistent with the ARRC's recommended
conventions, the concept document includes a lookback with no observation shift. On 29 July
2021, the ARRC announced that it was formally recommending the CME Group’s SOFR forward
looking Term Rates. On 9 August 2021, the LSTA published a Draft Term SOFR Concept
Document which reflects the ARRC’s recommended conventions, but also includes some
additional convention options.

Derivatives and other trading products

The International Swaps and Derivatives Association (ISDA) launched the IBOR Fallbacks Protocol
(the Protocol) on 23rd October 2020 for adhering parties, which is a multilateral method to amend
legacy derivatives (and certain other trading contracts), and the IBOR Fallbacks Supplement
(Supplement 70) to the 2006 ISDA Definitions (the Definitions) to implement robust fallbacks to
IBORs into transactions. The Protocol and Supplement 70 took effect on 25th January 2021. Mizuho
Bank, Ltd. and Mizuho International plc have both signed up to the Protocol.

The announcement made by the FCA on 5th March 2021 constitutes an “Index Cessation Event”
for all LIBOR settings under the Supplement and the Protocol, and as a result the fallback spread
adjustment will be fixed as of 5 March 2021 for all euro, sterling, Swiss franc, US dollar and yen
LIBOR tenors.

In respect of the ISDA Benchmarks Supplement, at the time of the Index Cessation Event the
LIBOR Floating Rate Options, as referenced in transactions incorporating the terms of the IBOR
Fallbacks or the Protocol, include a reference to a concept defined or otherwise described as an
“index cessation event” which in effect means that a “Priority Fallback” of the ISDA Benchmarks
Supplement will apply to the relevant transactions.

“Consequences of a Benchmark Trigger Event” of the ISDA Benchmarks Supplement will apply
only to the extent the “Priority Fallback” fails to provide a means of determining the index level.

Timely adherence to the Protocol is being encouraged by national working groups, including the
ARRC, as well as international bodies such as the Financial Stability Board.
Please note that the £RFR WG has recommended the following best practice milestones:
   i)      from 1 April 2021, cease initiation of new GBP LIBOR linked derivatives, bonds and
           securitisations that expire after the end of 2021;
   ii)     from 1 July 2021, cease initiation of new GBP LIBOR-linked non-linear derivatives
           that expire after the end of 2021; and
   iii)    by end Q3 2021, complete active conversion where viable.

However, the £RFR WG recognises that there will be limited circumstances when it may be
appropriate to enter into new GBP LIBOR-linked derivative contracts that expire after the end of
2021, for risk management of existing positions (or exposure resulting from existing contracts, and
to support active conversion). More details are available here.

Further best practice cessation milestones have also been published by regulatory bodies and
industry working groups in advance of LIBOR discontinuation:
    • JPY LIBOR – A sub-committee of the Bank of Japan has issued a milestone to ‘cease
        initiation of JPY LIBOR referencing interest rate swaps expiring after 2021’ by September
        end.
    • USD LIBOR – The Federal Reserve Board, the Office of the Comptroller of the Currency,
        and the Federal Deposit Insurance Corporation have issued supervisory guidance
        encouraging banks to “cease entering into new contracts that use USD LIBOR as a
        reference rate as soon as practicable and in any event by December 31, 2021”.

Mizuho expects clients to take these milestones into account when requesting to transact in new
LIBOR-linked linear derivatives with us.

In May 2021 ISDA published Supplement 74 to the 2006 ISDA Definitions for stand-alone overnight
RFR Rate Options for SONIA, SOFR, €STR, TONA, SARON, AONIA, CORRA, HONIA, SORA,
THOR, NZOIA and NOWA and Supplement 75 approaches to compounding/averaging to provide
for new RFR definitions and adopt conventions that more closely match the conventions adopted
by the loan market.

The FCA and £RFR WG are encouraging a broad-based transition to SONIA by the end of 2021
as the primary method to ensure contractual certainty and retain economic control. You can find
further information here and here.

Further information and resources
If you would like any further information, please contact your relationship manager or in relation to
Mizuho Bank, Ltd. email MHBK.IBOR.enquiries@mhcb.co.uk and in relation to Mizuho
International plc email MHI.IBOR.enquiries@uk.mizuho-sc.com.

For further information on the impact of the FCA recent announcement on the cessation of LIBOR
benchmarks, please see the Future Cessation and Non-Representativeness Guidance published
by ISDA.

You can find further information from the USD Alternative Reference Rates Committee (ARCC)
here, the Working Group on Sterling Risk-Free Reference Rates here, the Cross-Industry
Committee on Japanese Yen Interest Rate Benchmarks here and the EURRFR Working Group
here. You can also find publications from the LMA here and from ISDA here.

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