LIBOR: the countdown to 2021 - Helping business understand and prepare for the phasing out of LIBOR beyond 2021 - Bank of Scotland Business
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COMMERCIAL BANKING LIBOR: the countdown to 2021 Helping business understand and prepare for the phasing out of LIBOR beyond 2021 March 2019
2
1 Overview
“
Introduction considered, and activities being
The future of LIBOR (London Interbank undertaken, as financial and capital
Offered Rate) has been a major market participants prepare for
The market LIBOR
discussion topic since Andrew Bailey’s the potential cessation of LIBOR seeks to measure
speech in July 20171, where he beyond the end of 2021. A glossary
announced that it was the Financial of key terms is provided at the end is no longer
Conduct Authority’s (FCA’s) intention of the paper.
that it would no longer be necessary
sufficiently active.
for it to use its powers to persuade It is still too early for any consensus Engagement will
or compel the panel of banks that to have emerged on how the
contribute LIBOR quotes to do so transition from LIBOR and other be needed from
beyond the end of 2021. This has Interbank Offered Rates (IBORs)
led to significant activity amongst to alternative benchmarks will be
participants across
certain market participants and managed. However, at Bank of all relevant sectors
industry bodies, with working groups Scotland, we recognise these changes
set up in the UK and globally to have important implications for many and markets to
assess the implications of moving of our clients. We will continue
to alternative benchmarks. Following to engage with clients on market
transition away
on from this speech, Andrew Bailey developments and we welcome your from LIBOR.
”
provided a further update in July feedback. Please feel free to discuss
2018, where he further underlined any thoughts or concerns with
the need for markets to transition your Relationship Manager.
away from LIBOR2.
What is LIBOR?
Following on from the above LIBOR publication dates back to
announcements, the FCA and at least 1986 and since then it has
Prudential Regulation Authority (PRA) grown to become a global benchmark
wrote to the CEOs of major banks interest rate for financial products.
and insurers supervised in the UK
asking for the preparations and actions Currently, a reference panel of
they are taking to manage transition between 11 and 16 contributor
from LIBOR to alternative interest banks for each LIBOR currency
rate benchmarks. (GBP, EUR, USD, JPY, CHF) submit
daily interest rates for various periods
Whilst the letters were sent to the up to 12 months. LIBOR is then
largest banks and insurers in the calculated and published for each
first instance, the FCA and PRA relevant currency and tenor using
are encouraging all firms that a trimmed arithmetic mean of
currently rely on LIBOR to read the submitted rates.
and reflect on the letter. It is likely
that these letters will be a further Until contributing banks transition
catalyst for the acceleration of to the IBA Roadmap methodology
market transition activities3. they are asked to base their LIBOR
submissions in response to the
This introductory paper summarises question “At what rate could you
some of the key issues being borrow funds, were you to do so
1
Andrew Bailey, The future of LIBOR (July 7, 2017), available at https://www.fca.org.uk/news/speeches/the-future-of-libor
2
https://www.fca.org.uk/news/speeches/interest-rate-benchmark-reform-transition-world-without-libor
3
https://www.fca.org.uk/news/statements/dear-ceo-libor-letter
3
by asking for and then accepting Why is LIBOR likely to be phased out? market participants not to rely on
interbank offers in a reasonable market In July 2017 the FCA announced LIBOR’s continuation beyond 2021,
size just prior to 11am?” (As defined that it was its intention that it would and to make plans for transition.
in the Intercontinental Exchange (ICE) no longer be necessary for it “to
Benchmark Administration LIBOR persuade, or compel, banks to Why would LIBOR cessation be
Code of Conduct). This dates back to submit to LIBOR” or “to sustain the a big deal?
a time when banks utilised the short- benchmark through our influence or It is widely acknowledged that LIBOR
term wholesale funding markets to legal powers” after the end of 2021. is a key interest rate benchmark for
a greater degree than present. Reasons given by Andrew Bailey, hundreds of trillions of dollars in
the CEO of the FCA, for its decision financial products and contracts
The process is administered by the included the fact that the market worldwide, including corporate loans,
ICE Benchmark Administration (IBA) LIBOR seeks to measure i.e. derivatives, corporate bonds/FRNs,
and LIBOR was recently designated unsecured wholesale term lending to structured debt products, deposits
as a Critical Benchmark under newly banks, is no longer sufficiently active. and mortgages. It also plays a central
formed EU Benchmarks Regulation. role for many banks’ internal funding
The FCA also announced in benchmarks and Insurer Solvency
Other important IBORs are EURIBOR November 20174 that all current II balance sheets.
(Euro Interbank Offered Rate) and panel banks have agreed to continue
TIBOR (Tokyo Interbank Offered Rate). with LIBOR contributions until the Where existing contracts run into
end of 2021. This is intended to allow 2022 and beyond, market participants
sufficient time for a market-led solution will likely need to deploy resources to
to LIBOR transition to be developed review and amend documentation in
and implemented. order to confirm suitable replacements
to LIBOR as the reference rate,
The announcements have provided depending on the outcome of
greater impetus for regulators and a market-led solution.
market participants to accelerate
thinking about alternative benchmark For new contracts entered into before
rates and the implications of LIBOR 2022, market participants will need
and other IBORs potentially ceasing to employ appropriate fall-back
to exist. This has been further provisions in documentation in the
reinforced by Andrew Bailey’s speech absence of specific replacement
in July 2018 strongly encouraging benchmark rates.
FCA Statement published 24/11/17, available at https://www.fca.org.uk/news/statements/fca-
4
statement-libor-panels
4
An international effort Alternative benchmark rates being developed in other jurisdictions
Since 2014 a number of countries
have set up working groups to identify
Industry body / (Near) RFR recommendation*
near-Risk Free Reference Rates (RFRs)
as part of a G20 initiative, delegated to organisation deciding
the Financial Stability Board (FSB), to alternative rate
review and reform critical benchmark
rates. The FSB established an Official
Sector Steering Group (OSSG), to Working Group on Sterling SONIA, an unsecured overnight rate
focus the FSB’s work on the most RFR set up by BoE calculated by the Bank of England from
fundamental interest rate benchmarks. eligible transactions reported to them
via their sterling money market daily
Each of the RFRs chosen as potential data collection process in accordance
alternatives to LIBOR brings its own with form “SMMD”. Reformed SONIA
challenges. For instance, some are has been published since April 2018
based on secured and others on
unsecured transactions. There is also Working Group on RFR for The ECB announced on the 13th
presently a lack of liquidity in markets the Euro Area, formed by September 2018 that the private sector
referencing these benchmarks (where FSMA, ESMA, ECB and the working group had recommended
they exist) and none of the solutions European Commission ESTER as the alternative euro risk-free
identified so far offers a term structure rate. ESTER reflects wholesale euro
similar to LIBOR. In fact they are all unsecured overnight borrowing costs
overnight rates, whereas LIBOR tenors of euro area banks and will be
go out to one year, with 3 month and produced by the ECB at the latest as
6 month tenors, in particular, being of October 2019
extensively used in derivative and
loan / bond markets.
Alternative Reference Rates SOFR, a new, broad US Treasuries
Different countries are at different Committee, convened by repo financing rate published since
stages of preparedness for the Federal Reserve April 2018
transitioning to an alternative
benchmark. In the UK, there already Study Group on RFR TONAR (Tokyo Overnight Average
exists a relatively liquid Sterling Rate), an uncollateralised overnight
Overnight Index Average (SONIA) call rate
swap market. The US has only recently
started publishing Secured Overnight
Financing Rate (SOFR) which was The National Working SARON (Swiss Average Rate Overnight),
followed by the launch of a Futures Group on CHF Reference which references actual market
market. In the Eurozone, the Euro Rates (NWG) transactions in the Swiss Franc interbank
Short-Term Rate (ESTER) is yet to be repo market (i.e. secured)
published, let alone having a market
that can reference it. * These recommendations will help develop an alternative for LIBOR over time.
5What is the Bank of England doing The working group has identified
to aid LIBOR transition? that active engagement will be
The Bank of England (BoE) has needed from participants across
initiated a working group on Sterling all relevant sectors and markets
RFR (the ‘working group’), which to transition away from LIBOR.
has recommended a reformed As a result, a number of
SONIA as the preferred Sterling sub-working groups have been
RFR as an alternative to GBP LIBOR. set up, each with a different
The BoE define SONIA as “a measure industry and product focus.
of the rate at which interest is paid
on sterling short-term wholesale
funds in circumstances where the
credit, liquidity and other risks
are minimal”5.
Sterling RFR Working Groups
Working Group on The Working Group on Sterling
The ACT / LMA and other trade
Sterling RFRs RFRs is actively engaged with each
bodies are represented at a
of the other currency working groups
cross section of the below
and with the FSB’s OSSG on
groups and forums.
benchmark reform.
Technical Sub Groups Stakeholder Forums
Loan Markets Market Infrastructure Banking Industry
Bond Markets Pension Funds and Investment Managers
Insurance Companies
Communications & Outreach Non-financial Corporates
Cross-currency swaps
Term SONIA Reference Rates (international)
5
BoE SONIA Key features and policies, available at https://www.bankofengland.co.uk/-/media/boe/files/markets/benchmarks/sonia-key-
features-and-policies
6How is Bank of Scotland preparing for the transition away from LIBOR and other IBORs?
Bank of Scotland is preparing Lloyds Banking Group is Bank of Scotland will continue
itself for IBOR transition by represented on the Working Group to engage with clients on market
engaging with clients on the on Sterling RFR, which was initiated developments. In the meantime we
consequences of potential to assist the BoE in meeting its recommend clients raise awareness
cessation of LIBOR, and other objective of developing sterling internally of changes that may
IBORs, and commence transition RFRs. It is also active on a number be coming and keep abreast
work to alternative benchmarks. of the BoE facilitated industry-wide of future developments.
sub-groups that have been set up,
including the Loan Markets, Bond
Markets, Term SONIA and SONIA
Futures sub-groups.
“ In September 2018 Lloyds Bank plc
became the first UK Retail and
Commercial lender to price a bond
using SONIA as its reference rate.
”
72 Transition Challenges:
Key Areas of Debate
In the UK, reformed SONIA has been selected as the Sterling
near-RFR. However, there are a number of challenges to
overcome in transitioning away from LIBOR.
Fall-back provisions use protocols and not all derivatives value transfer; (2) eliminating
Most financial instrument documents will be documented under ISDA. or minimising any potential for
include provisions to guide how the manipulation; and (3) eliminating
interest rates would be set if LIBOR LMA is also reviewing its fall-back or mitigating against the impact of
is no longer available for example provisions: it currently provides market disruption at the time the
in a contingency event such as IT optional wording for new contracts, fall-back is applied. Even a simple
failure. However, these were designed allowing for a replacement benchmark change such as referencing daily
to address temporary and not in case of an unforeseen event, where compounding SONIA, plus x bps
permanent disruptions in relation the screen rate is unavailable, or more instead of LIBOR may result in some
to LIBOR and are therefore unlikely recently, anticipating uncertainty over value transfer due to changes in
to provide a long-term solution. the future of LIBOR, if a replacement market value following a change in
benchmark is adopted, with the the benchmark interest rate. The ISDA
Industry groups such as the consent of the borrower group and consultation discusses this topic and
International Swaps and Derivatives majority lenders (instead of requiring looks at various options. There may
Association (ISDA) and Loan Market all-lender consent9). also be accounting and tax issues,
Association (LMA) have been as many corporates use LIBOR as the
reviewing their respective fall-back No matter whether majority or RFR for derivative valuation purposes.
provisions. For instance, ISDA has all-lender consent is required, it is
established a working group to likely to be operationally burdensome Some participants in the pensions
identify and implement new fall-back to make a change, as each individual Liability Driven Investment (LDI)
provisions for certain key IBORs if loan agreement would need to market that tend to transact
they are discontinued. In July 2018 be amended. collateralised swaps see some
they launched a consultation on benefit in transitioning sooner rather
Benchmark fallbacks, the consultation In line with expectations from the than later to SONIA-based swaps.
sets out options for adjustments Official Sector (e.g. Regulators
that would apply to the fallback rate and Central Banks) the market needs For those participants, their derivatives
in the event an IBOR is permanently to consider, prepare and agree are already typically valued off a
discontinued6. On 27th November alternatives for an orderly transition. SONIA curve and therefore some see
2018 ISDA published preliminary an advantage to moving to SONIA-
results of the consultation7, with Considerations in derivative markets based swaps if there is sufficient
a final summary published on 20th The ISDA working group has liquidity in the OIS market.
December 2018.8 considered fall-backs for LIBOR to an
adjusted RFR plus spread adjustment. Considerations in loan and
For derivatives, fall-backs are likely Proposals for an adjusted RFR are bond markets
to be based on the relevant RFR, with measured against the following A key concern for certain sectors in
an adjustment to reflect differences in criteria: (1) simplicity and ease of the loan and bond markets is retaining
the calculation methodology for RFRs calculating; (2) data requirements; a forward-looking term structure in
versus LIBOR. For adhering parties, and (3) similarity with the structure RFR as an alternative to LIBOR.
ISDA has a protocol system for of Overnight Index Swaps (OIS).
amending legacy contracts which may Proposals for a spread adjustment One issue is that SONIA is an
allow for a more streamlined process are measured against the following overnight rate, and backward looking,
in some cases, though not all entities criteria: (1) eliminating or minimising whereas some borrowers and lenders/
6
http://assets.isda.org/media/f253b540-193/42c13663-pdf/
7
https://www.isda.org/2018/11/27/isda-publishes-preliminary-results-of-benchmark-consultation/
8
https://www.isda.org/2018/12/20/isda-publishes-final-results-of-benchmark-fallback-consultation/
9
LMA publishes revised Replacement of Screen rate clause to provide further flexibility in light of uncertainty over the future of LIBOR,
available at http://www.lma.eu.com/libor
8investors have a preference for needs to be a high degree of
certainty of cash flow that can cooperation across the various
only be provided by a sub-groups established by the
forward-looking measure. BoE and market sectors as well as
coordination across IBOR jurisdictions.
The Term SONIA sub-working group
is looking into how a forward-looking The Working Group on Sterling
rate can be constructed from SONIA Risk-Free Reference Rates has
and in July 2018 they launched a recently published a paper12 setting
consultation on Term SONIA rates10. out some of the market uncertainties
The consultation acknowledges the surrounding issuance of bonds
need in some areas of the market for referencing LIBOR that mature
a forward looking term SONIA beyond 2021.
reference rate. In November 2018 What next?
they announced a summary of Legal considerations include: In his July 2018 speech, Andrew Bailey
responses to the consultation11. changes to new documentation, said: “The discontinuation of LIBOR
transitioning to successor rates and should not be considered a remote
Any vulnerability resulting from amending existing documentation possibility” and “the biggest obstacle
relying on another quoted market (including amending in accordance to a smooth transition is inertia –
must be considered and Term with existing requirements), the a hope that LIBOR will continue,
SONIA may just be a stop-gap inclusion of fall-back provisions and or that work on transition can be
measure, rather than a long term the potential for divergence in terms delayed or ignored. Misplaced
solution, as the market gets used to of approaches given the bespoke confidence is a risk to financial stability
using a daily compounding SONIA. nature of deals and documents. as well as to individual firms.”
A further concern is if the swap market The process for transitioning to In the first instance, firms are
changes in a different way to the loan alternative rates and the practical encouraged to review existing LIBOR
and bond markets, as this could give implications, including potential exposures and fall-backs, paying
rise to basis risk and volatility in P&L systems changes, are also key particular attention to those which
for hedge accounting packages. There considerations. mature after 2021. This review could
include the creation of an overall
“
inventory of products and systems
used to capture such exposures.
Awareness of benchmark transition Following the recent ISDA and Term
needs to be raised. The market needs to SONIA consultations, and that the
anticipated implementation of these
consider, prepare and agree alternatives could be in H2 2019, we expect the
transition to alternative benchmarks
for an orderly transition.
”
to accelerate.
10
https://www.bankofengland.co.uk/paper/2018/consultation-paper-on-term-sonia-reference-rates
11
https://www.bankofengland.co.uk/-/media/boe/files/markets/benchmarks/term-sonia-reference-rates-consultation-summary-of-
responses.pdf
12
https://www.bankofengland.co.uk/-/media/boe/files/markets/benchmarks/risk-free-reference-rates-new-issuance-of-sterling-bonds-
referencing-libor.pdf
93 Countdown to LIBOR
reform in the UK
Timeline of steps to reform LIBOR in the UK
UK Government commissioned The FCA announced that it will no
Martin Wheatley to undertake longer be exerting its influence
a review of the framework for The FSB undertook a LIBOR
and legal powers to persuade
the setting of LIBOR with review of benchmark potentially
banks to submit reference rates
recommendations published rates and published ceases
beyond the end of 2021; as a
in September 2012 ‘Reforming Major Interest result, LIBOR may be phased out
Rate Benchmarks’ by the end of 2021
The FSB established an Official
Sector Steering Group (OSSG),
which comprises senior officials
from central banks and
regulatory agencies, to focus
the FSB’s work on the interest
rate benchmarks that are FSB regularly publishes progress
considered to play the most reports on implementation of Developing proposals
fundamental role in the global the recommendations laid out in for the transition to
financial system the 2014 FSB report alternative benchmarks
2012 2013 2014 2015 2016 2017 2018 - 2021
FCA authorised ICE The working Group on
Benchmark Administration Sterling RFR announced
to take over calculation SONIA as its preferred near
and publication of LIBOR RFR for use in sterling
derivatives and relevant
Since the financial crisis, the financial contracts
underlying market LIBOR seeks to
measure has slowed down
significantly. As a result, the G20 Most provisions of EU
asked the Financial Stability Board Benchmarks Regulation
(FSB) to review critical benchmark come into effect.
rates, including LIBOR and EURIBOR, LIBOR designated
and develop plans for their reform a critical benchmark
104 Glossary
ACT: Association of Corporate G20: Group of 19 individual OIS: Overnight Indexed Swap
Treasurers countries plus the
European Union OSSG: Official Sector Steering
BOE: Bank of England Group
IBORs: Interbank Offered Rates
ECB: European Central Bank P&L: Profit and Loss
ICE: Intercontinental Exchange
ESMA: European Securities and PRA: Prudential Regulation
Markets Authority ICE BA: ICE Benchmark Authority
Administration Ltd
EURIBOR: Euro Interbank Offered RFR: Risk Free Reference Rate
Rate ISDA: International Swaps and
Derivatives Association SARON: Swiss Average
FCA: Financial Conduct Rate Overnight
Authority LDI: Liability Driven Investment
SOFR: Secured Overnight
FRNs: Floating Rate Notes LIBOR: London Interbank Offered Financing Rate
Rate
FSB: Financial Stability Board SONIA: Sterling Overnight Index
LMA: Loan Market Association Average
FSMA: inancial Services and
F
Markets Authority NWG: National Working Group TONAR: Tokyo Overnight Average
Rate
5 Contributors
ALBERT SHAMASH STEVE BULLOCK
Managing Director, Business Head of Benchmark
Development and Innovation, Submission and Supervision,
Financial Institutions Group Corporate Treasury
Lloyds Bank Lloyds Bank
E: albert.shamash@lloydsbanking.com E: steve.bullock@lloydsbanking.com
11Get in touch
Bankofscotland.co.uk
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