LIBOR: to 2021 the countdown - Helping business understand and prepare for the phasing out of LIBOR beyond 2021 - Lloyds Bank
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LIBOR:
the countdown
to 2021
Helping business
understand and prepare
for the phasing out of
LIBOR beyond 2021
May 2020
By the side of business
LIBOR: the countdown to 2021
Overview
Background
The future of the London Interbank Offered Regulation Authority (PRA) wrote to • The RFRWG priorities and roadmap9
Rate (LIBOR) has been a major discussion the CEOs of major banks and insurers for 2020
topic since Andrew Bailey’s speech in July supervised in the UK (in September 2018),
20171, where he announced that it was asking for details of the preparations • A paper10 setting out the RFRWG’s
the Financial Conduct Authority’s (FCA’s) and actions they are taking to manage views on the appropriate use of SONIA
intention that it would no longer use its transition from LIBOR to alternative interest (Sterling Overnight Index Average rate)
powers to persuade or compel the panel rate benchmarks. compounded in arrears and guidance for
of banks that contribute LIBOR quotes where the use of alternative approaches,
to do so beyond the end of 2021. This Whilst the letters6 were sent to the largest such as a Term SONIA Reference Rate,
has led to significant activity amongst banks and insurers in the first instance, the may be necessary
market participants and industry bodies, FCA and PRA are encouraging all firms that
with working groups set up in the UK and currently rely on LIBOR to read and reflect • A statement11 considering ‘lessons
globally to assess the implications of on their letter. learned’ from recent conversions of
moving to alternative benchmarks and the legacy LIBOR contracts
implications of LIBOR cessation. Following On the 5 June 20197 the Bank of England
on from this speech, Andrew Bailey (BoE), the FCA and the Working Group on • A factsheet12 for end-users summarising
provided further updates in July 20182 and Sterling Risk Free Reference Rates (RFRWG) LIBOR transition, and setting out why
July 20193, where he further underlined jointly held a conference on the work market participants need to act now.
the need for markets to transition away underway to transition from GBP LIBOR to
from LIBOR. alternative risk-free interest rates. Whilst The end-user factsheet in particular was a
the principles in this paper are relevant to all key priority for the RFRWG Communication
Latest updates to this document are five of the LIBOR currencies the discussion sub-group, and is designed as a guide to
being made at a time when Coronavirus focussed primarily on GBP LIBOR and widen awareness of LIBOR transition with
(COVID-19) is impacting events globally. its alternatives. broad dissemination in mind.
In connection with LIBOR transition the
FCA published an update 4 on its website In January 2020 the BoE, the FCA and the Also included with this update was a
on 25 March confirming that firms should RFRWG issued8 a joint statement providing letter13 from the FCA and the BoE to major
continue to work on the assumption that an update on next steps for transition. banks and insurers setting out their initial
LIBOR will cease at the end of 2021. A expectations of firms’ transition progress
further update5 was published on 29 April, The material published on the RFRWG during 2020. Amongst other things the
confirming the same position but also webpage highlights a number of important letter highlights that “2020 will be a key year
noted some changes in relation to Loan events scheduled for 2020 and clarifies for transition” and that “The intention is
transition milestones. actions that market participants should take for sterling LIBOR to cease after the end of
to reduce their LIBOR exposures ahead of 2021. No firm should plan otherwise”.
In connection with Andrew Bailey’s earlier the end of 2021. These materials encourage
speeches the FCA and the Prudential market participants to refer to:
1
Andrew Bailey, The future of LIBOR (July 27, 2017), available at https://www.fca.org.uk/news/speeches/the-future-of-libor
2
Andrew Bailey, Interest rate benchmark reform: transition to a world without LIBOR, available at https://www.fca.org.uk/news/speeches/interest-rate-benchmarkreform-
transition-world-without-libor
3
Andrew Bailey, LIBOR: Preparing for the end available at https://www.fca.org.uk/news/speeches/libor-preparing-end
4
Impact of the coronavirus on firms LIBOR transition plans.
5
Further statement on the impact of Coronavirus
6
Dear CEO letter, available at https://www.fca.org.uk/news/statements/dear-ceo-libor-letter
7
Last Orders Calling Time on LIBOR event https://www.bankofengland.co.uk/events/2019/june/last-orders-calling-time-on-libor
8
Next Steps for LIBOR transition in 2020: the time to act is now
9
RFRWG 2020 Top Level Priorities and Roadmap
10
Use Cases of Benchmark Rates: Compounded in Arrears, Term Rate and Further Alternatives
11
Progress on the Transition of LIBOR-Referencing Legacy Bonds to SONIA By Way Of Consent Solicitation
12
Calling Time on LIBOR: Why you need to act now
13
Joint PRA / FCA Letter to Senior Managers : Next Steps on LIBOR transition
2
LIBOR: the countdown to 2021
This paper also summarises some of the key IBA, and LIBOR has been designated as a reinforced by Andrew Bailey’s speeches in
issues being considered and activities being Critical Benchmark under EU Benchmarks July 2018 and July 2019, and other speeches
undertaken, as financial and capital market Regulation (BMR). Other important IBORs from the FCA and regulators globally,
participants prepare for the potential are EURIBOR (Euro Interbank Offered Rate) strongly encouraging market participants
cessation of LIBOR beyond the end of 2021. and TIBOR (Tokyo Interbank Offered Rate). not to rely on LIBOR’s continuation beyond
2021, and to make plans for transition.
At Lloyds Bank, we recognise these changes Why is LIBOR being phased out?
have important implications for many of In July 2017 the FCA announced that it Why would LIBOR cessation be a big deal?
our clients. We will continue to engage with was its intention to no longer “persuade, LIBOR is a key interest rate benchmark
clients on market developments, transition or compel, banks to submit to LIBOR” or used for hundreds of trillions of dollars in
plans and we welcome your feedback. “to sustain the benchmark through our financial products and contracts worldwide
Please feel free to discuss any thoughts or influence or legal powers” after the end of including; corporate loans, derivatives,
concerns with your Relationship Manager. 2021. In his 2017 speech Andrew Bailey, corporate bonds/FRNs, structured debt
the CEO of the FCA, stated “the underlying products, deposits and mortgages. It
What is LIBOR? market that LIBOR seeks to measure also plays a central role for many banks’
LIBOR publication dates back to at least – the market for unsecured wholesale internal funding benchmarks and Insurance
1986 and since then it has grown to become term lending to banks – is no longer companies’ Solvency II balance sheets.
a global benchmark interest rate for sufficiently active”.
financial products. Where existing contracts run into 2022
The FCA also announced in November and beyond, market participants will need
Currently, a reference panel of between 11 201715 that all current panel banks to deploy resources to review and amend
and 16 contributor banks for each LIBOR had agreed to continue with LIBOR documentation in order to confirm suitable
currency (GBP, EUR, USD, JPY, CHF) submit contributions until the end of 2021. This replacements to LIBOR as the reference
daily interest rates for various periods up was intended to allow sufficient time for a rate, depending on the outcome of a
to 12 months. LIBOR is then calculated market-led solution to LIBOR transition to market-led solution.
and published for each relevant currency be developed and implemented.
and tenor. For new contracts entered into before
The announcements have provided 2022, market participants will need to
Contributing banks are required to greater impetus for regulators and market employ appropriate fallback provisions in
formulate submissions in accordance participants to accelerate thinking about documentation, although regulators have
with the methodology requirements14 alternative benchmark rates and the been actively encouraging LIBOR users
published by ICE Benchmark Administration implications of LIBOR and other IBORs to transition away from the benchmark
(IBA). The benchmark is administered by potentially ceasing to exist. This was further rate ahead of 2021 rather than relying
on fallbacks.
In connection with this initiative RFRWG
Loans Enablers Task Force published a
guide16 in March 2020 which provides
information and an indicative roadmap
The market LIBOR seeks to measure is no longer to meet the RFRWG target. The paper
is intended to act as a guide for lenders,
sufficiently active. Engagement will be needed from borrowers and infrastructure providers in
participants across all relevant sectors and markets to determining steps within their firms to meet
this timeline.
transition away from LIBOR.
14
ICE LIBOR methodology
15
FCA Statement published 24/11/17 on LIBOR Panels
16
RFRWG Loans Enablers Task Force guide March 2020
3LIBOR: the countdown to 2021
An international effort
Since 2014 a number of countries have set The US started publishing Secured Reference Rates Committee (ARRC) (the
up working groups to identify near-Risk Overnight Financing Rate (SOFR) in April US equivalent of the Sterling RFRWG) has
Free Reference Rates (RFRs) as part of a 2018 which was followed by the launch of published a paced transition plan with
G20 initiative, delegated to the Financial a futures market. A swap market exists but key milestones to transition away from
Stability Board (FSB), to review and reform has been slower to take off. The Alternative USD LIBOR by the end of 2021. It has also
benchmark rates. The FSB established
an Official Sector Steering Group (OSSG),
to focus the FSB’s work on the most Alternative benchmark rates developed for all 5 LIBOR currencies
fundamental interest rate benchmarks.
Each of the RFRs that are potential Industry body / organisation (Near) RFR recommendation*
alternatives to LIBOR has challenges. For deciding alternative rate
instance, some are based on secured and
others on unsecured transactions. There is
also presently a lack of liquidity in some of Working Group on Sterling SONIA, an unsecured overnight rate
the markets referencing these benchmarks RFR set up by BoE calculated by the Bank of England from
and none of the solutions identified so far eligible transactions reported to them
offers a forward-looking, term structure via their sterling money market daily data
similar to LIBOR. In fact they are all collection process in accordance with
backward-looking overnight rates, whereas form “SMMD”. Reformed SONIA has been
LIBOR tenors go out to one year, with 3 published since April 2018
month and 6 month tenors, in particular,
being extensively used in derivative and
loan/bond markets. Working Group on RFR for the The ECB announced on the 13 September
Euro Area, formed by FSMA, 2018 that the private sector working group
Different countries are at different stages ESMA, ECB and the European had recommended €STR as the alternative
of preparedness for transitioning to an Commission Euro risk-free rate. €STR reflects wholesale
alternative benchmark. In the UK, there Euro unsecured overnight borrowing costs
already exists a relatively liquid Sterling of Euro area banks and is expected to be
Overnight Index Average (SONIA) swap published from 2 October 2019
market and this is expected to increase
following recent guidance17 from the BoE
Alternative Reference Rates SOFR, a new, broad US Treasuries repo
and the FCA, that market makers should
Committee, convened by the financing rate published since April 2018
change the convention for sterling interest
Federal Reserve
rate swaps from LIBOR to SONIA from
2 March 2020 (the intention is that market
makers will quote SONIA swap prices to Study Group on RFR TONAR (Tokyo Overnight Average Rate),
clients and market participants ahead of an uncollateralised overnight call rate
LIBOR prices).
This January 2020 guidance also noted that The National Working Group SARON (Swiss Average Rate Overnight),
“The market for SONIA derivatives is already on CHF Reference Rates which references actual market transactions
well-established. Average cleared over-the- (NWG) in the Swiss Franc interbank repo market
counter SONIA swaps exceeded £4.5trillion (i.e. secured)
per month over the past six months, and
the traded monthly notional value is now
* These recommendations will help develop alternatives for LIBOR over time.
broadly equivalent to Sterling LIBOR”.
17
F CA and Bank of England encourage switch from LIBOR to SONIA for sterling interest rate swaps from
Spring 2020
4LIBOR: the countdown to 2021
instituted weekly calls to brief the market Index Average (EONIA) and EURIBOR recommended a reformed SONIA as the
and take questions as long as there is have recently been changed. preferred Sterling RFR as an alternative
sufficient interest. The ARRC provided Since 2 October 2019 EONIA (often to GBP LIBOR. The BoE define SONIA as
an update on its key objectives for 2020 referenced in EUR collateralised derivative “a measure of the rate at which interest
in April18. contracts) has been quoted as €STR plus a is paid on sterling short-term wholesale
fixed spread of 8.5 basis points, published funds in circumstances where the credit,
In the Eurozone, the phasing out of on a T+1 basis and is likely to continue liquidity and other risks are minimal”22.
EURIBOR is running at a slower pace than until end 202120 when EONIA will cease to The working group has identified that
LIBOR and there is no proposed cessation be published. During 2019 the EURIBOR active engagement will be needed from
date. In the near term EURIBOR has been submission methodology changed and it participants across all relevant sectors and
reformed to comply with the requirements now follows a similar hybrid methodology21 markets to transition away from LIBOR. As a
of the EU Benchmarks Regulation (BMR), as adopted by the IBA for LIBOR. result, a number of sub-working groups and
although its long-term future remains task forces have been set up, each with a
uncertain. The Euro Short-Term Rate19 What is the Bank of England doing to aid different industry and product focus.
(€STR) commenced publication from LIBOR transition?
2 October 2019. The calculation The BoE has initiated a working group The working group is publishing a monthly
methodology for both the Euro Overnight on Sterling RFR (the RFRWG), which has newsletter with key news relating to RFR
transition in GBP markets and others.
Sterling RFR Working Groups
Q1 Q2 Q3 Q4 2021
Statement of 2020 RFR Working Group
Ongoing education and awareness campaigns, including a series of webinars,
priorities and supporting documents:
Communication
roundtables and events
Working Group
• Factsheet for end users
• Consent solicitation statement
• Term Rate Use Case Paper
Q1 Event: communicate Q3 target to Ongoing communications to cash
Corp/Mid-Corp/SMEs/Specialist Finance market stakeholders
Swaption conventions: Anonymised
survey feedback published
‘Tough Legacy’: Loans Enablers taskforce
RFR Working Group
paper published publish detailed roadmap to
Q3 target Cash credit spread adjustment:
summary feedback published
Deliverables
Cash legacy transition
paper published
Term Rate: provisional Term Rate: provisional publish Term Rate: provisional live
development for dealers to an initial ‘beta’ term rate to be Term Rate published
stream prices to venues used for testing purposes
Q1 TARGET Q1 2021
Key infrastructure available from Treasury TARGET
Management Systems and loans vendors to Stock of
Market Developments
use compounded SONIA LIBOR
Interest rate swap conventions referencing
change from LIBOR to SONIA contracts
significantly
ISDA protocol expected to be ISDA protocol: expected target for reduced
published, introducing amended adoption
fallback terms for IBORs in definitions
and protocol
Communication Conventions WG Deliverables Term Rate Key Market targets ISDA Developments
18
ARRC Key Objectives for 2020
19
ECB Press Release, 14 March 2019
20
ECB working group recommends ESTER as euro risk-free rate
21
EMMI blueprint for the hybrid methodology for the determination of EURIBOR
22
BoE SONIA Key features and policies
5LIBOR: the countdown to 2021
How is Lloyds Banking Group preparing for the transition away from LIBOR and other IBORs?
Lloyds Bank is preparing itself for Lloyds Banking Group is
In September 2018 Lloyds
IBOR transition, with the primary represented on the Working Group Bank plc became the first
objective to position the Group
for, and engage with clients on,
on Sterling RFR, which was initiated
to assist the BoE in meeting its
UK Retail and Commercial
the consequences of potential objective of developing sterling lender to price a bond
cessation of LIBOR, and other
IBORs, and commence transition
RFRs. It is also active on a number
of the BoE facilitated industry-wide
using SONIA as its
work to alternative benchmarks. sub-groups that have been set up, reference rate. It launched
including the Loan Markets, Bond
and Infrastructure sub-groups and the first securitisation
Lloyds Bank will continue to
Term Sonia Task Force. referencing SONIA in
engage with clients on market December 2018.
developments. In the meantime
we recommend clients raise Lloyds Bank is active in Sterling In 2019 and following
awareness internally of changes swaps referencing both LIBOR and consent solicitation
that may be coming and keep SONIA and has been facilitating
abreast of future developments. transitions to SONIA for some clients. exercises Lloyds Bank plc
also agreed with
noteholders to switch
the interest payments on
certain debt instruments
from LIBOR to SONIA and
this has been followed
in 2020 with further
successful exercises.
Lloyds Banking Group has
also been developing and
launching a suite of new
products that reference
the selected RFRs.
6LIBOR: the countdown to 2021
Transition Challenges:
Key Areas of Debate
In the UK, reformed SONIA has By way of example, what this means for ISDA has a protocol system to which parties
been selected as the Sterling RFR23. a sterling interest rate swap is that the may adhere in order to amend legacy
However, there are a number calculation method will measure the contracts (to incorporate the fallbacks
of challenges to overcome in difference between LIBOR and SONIA over discussed above), which may allow for a
transitioning away from LIBOR either a five year historical period (prior to and relatively streamlined process. Although
before or at the point of cessation. ending at the point of an announcement of not all entities will use protocols and not all
GBP LIBOR cessation). Under the proposals derivatives will be documented under ISDA.
Fallback provisions the LIBOR component of the swap would be The protocol is also scheduled to come into
Most financial instrument documents include replaced with SONIA plus a median of the effect in 2020.
provisions to guide how interest rates will five year spread. The calculation includes two
be set if LIBOR is no longer available, for components which seek to measure both the LMA is also reviewing its fallback provisions:
example in a contingency event such as an credit spread (mentioned above) and term it currently provides optional wording for
IT failure. However, these provisions were adjustments between the RFR (which is an new contracts, allowing for a replacement
originally designed to address temporary, overnight rate) and the relevant LIBOR tenor. benchmark in case of an unforeseen
rather than permanent, LIBOR cessation event, for example where the screen rate is
and are therefore unlikely to provide a long- Supplemental consultations were launched unavailable; or more recently, anticipating
term solution. in May 2019 for USD LIBOR (and other uncertainty over the future of LIBOR if a
benchmarks) and in December 2019 for replacement benchmark is adopted with the
Industry groups such as the International EURIBOR and EUR LIBOR. consent of the borrower group and majority
Swaps and Derivatives Association (ISDA) and lenders (instead of requiring all-lender
Loan Market Association (LMA) have been In July 201925 ISDA announced that consent27). In the US market, the ARRC has
reviewing their respective fallback provisions. Bloomberg Index Services Limited had published example fallback provisions for use
ISDA established a working group to identify been selected to calculate and publish in both bilateral and syndicated loans. No
and implement new fallback provisions for adjustments related to the fallbacks that matter whether majority or all-lender consent
certain key IBORs if they are discontinued. In ISDA intends to implement for certain is required, it is likely to be operationally
2018 they launched a consultation on how interest rate benchmarks in its 2006 ISDA burdensome to make a change, as each
a fallback rate should be calculated which Definitions. Bloomberg is expected to publish individual loan agreement will need to
revealed a market preference for a fallback the historical fallback rate adjustments from be amended.
to a RFR “compounded set in arrears” with a around Q2 2020 and has published a set of
“historic mean/median” spread adjustment FAQs26 on this topic. Bilateral renegotiations are more difficult
for legacy contracts24. Following further in the public bond market and fallbacks
consultations a median five year look back The language to incorporate the fallback rates may require additional consideration. In
has been selected as the fallback. As LIBOR will be included within ISDA 2006 definitions the US, the ARRC has discussed potentially
incorporates a measure of both term risk and during 2020 meaning that any new contracts approaching the state of New York to seek
bank credit risk in its calculation, which RFRs will automatically incorporate these fallbacks. a legislative release which would clarify the
do not, a spread adjustment is required to fallback mechanism if LIBOR is no longer
preserve an equivalent economic position published and avoid widespread disruption to
insofar as possible. the market. An update28 on this was provided
by the ARRC in March 2020.
23
SONIA Recommended as the sterling near risk free interest rate benchmark
24
ISDA Press Release, 20 December 2018
25
ISDA Press Release 31 July 2019
26
Bloomberg IBOR Fallback Rate Adjustments FAQ
27
LMA LIBOR Microsite
28
A
lternative Reference Rate Committee – LIBOR & Potential New York State Legislation
7LIBOR: the countdown to 2021
In January 2019, Edwin Schooling Latter The update also stated that due to the
from the FCA delivered a speech highlighting agreement in place with LIBOR panel banks
contractual fallbacks and the need for to remain on the LIBOR panels until end-2021,
“The Task Force considered market participants to focus on these ahead the FCA do not expect LIBOR to cease or
that use of SONIA of any potential cessation of LIBOR29. He
speculated on how LIBOR may eventually
become non-representative before end-2021.
compounded in arrears end. For example, following the departure In line with expectations from the Official
of one or more panel banks, the Regulator Sector (e.g. Regulators and Central Banks)
was appropriate and is likely may determine that a benchmark is no longer the market needs to consider, prepare and
operationally achievable for representative of the underlying market, and agree alternatives for an orderly transition. In
suggested that this may be a suitable fallback connection with this ISDA launched a further
approximately 90% of new trigger. However, he went on to state “The consultation in May 2019. The consultation
loan deals by value and that best and smoothest transition from LIBOR related to pre-cessation issues and sought
will be one in which contracts that reference comment on how derivatives contracts
alternative rates would likely LIBOR are replaced and amended before should address a regulatory announcement
be required for 10% of new fallback provisions are triggered”. that LIBOR or certain other IBORs
categorised as critical benchmarks under
loan deals by value based In a March 2020 update30 the FCA outlined the EU Benchmarks Regulation are no longer
on the anonymous survey how they would announce to the market
details of such an event. The update confirms
representative of an underlying market.
carried out by the that this would be made via the Regulatory Preliminary results from this consultation
Task Force”. News Service, at the same time as, or very
shortly followed by, a posting of a fuller
were published in August 201931 however no
overall consensus was reached on how to
statement on their website. implement the pre-cessation fallbacks. Since
the consultation there has been a number of
exchanges between the Financial Stability
Board32 and ISDA33 on how pre-cessation
events may be included within ISDA contracts.
29
Edwin Schooling Latter, LIBOR transition and contractual fallbacks
30
FCA update on LIBOR contractual triggers
31
Preliminary Results of ISDA Pre-cessation Issues Consultation
32
Financial Stability Board letter to ISDA
33
ISDA response to Financial Stability Board
8LIBOR: the countdown to 2021
Following those exchanges, which included Investment (LDI) market that tend to transact Following this, during 2019, four potential
responses to certain questions that ISDA collateralised swaps see some benefit in Term SONIA benchmark administrators
had raised, in February 2020 ISDA launched transitioning sooner rather than later to presented their proposals for a Term SONIA
a re-consultation34 on pre-cessation events. SONIA-based swaps. For those participants, rate (TSRR) to the RFRWG, and they provided
This consultation proposes, subject to certain their derivatives are already typically valued a progress update in May 201938.
conditions in relation to the consultation off a SONIA curve and therefore some see
responses being met, that the 2006 ISDA value in moving to SONIA-based swaps if In January 2020 the RFRWG published39 a
Definitions will be amended to include there is sufficient liquidity in the OIS market. paper titled “Use Cases of Benchmark Rates:
fallbacks that would apply to all covered Compounded in Arrears, Term Rate and
derivatives following the permanent Grandfathered OTC derivatives may become Further Alternatives”.
cessation of an IBOR or a ‘non-representative’ subject to regulations requiring those
pre-cessation event, whichever occurs first. derivatives to be submitted for clearing The Task Force considered that use of SONIA
Under this scenario, the fallback protocol or collateralised in accordance with the compounded in arrears was appropriate
referred to above would also be launched uncleared margin rules upon material and is likely operationally achievable for
with both pre-cessation and permanent amendment. The Basel Committee on approximately 90% by value of the Sterling
cessation triggers for the fallbacks to apply to Banking Supervision and the International LIBOR loan market sampled and that the
participants’ legacy derivatives trades. Organization of Securities Commissions remaining 10% by total loan value would likely
have released a statement advising that require alternative rates.
Considerations in derivative markets amendments to legacy derivative contracts,
In agreeing fallbacks for LIBOR to an adjusted in response to benchmark reforms, do The paper also notes some other potential
RFR plus spread adjustment the ISDA working not require the application of margin use cases including: Trade and working capital
group considered a number of criteria: requirements35. However, the situation may products such as supply chain finance and
depend upon relevant implementing laws. receivable facilities; and other areas including
1. Simplicity and ease of calculating; Export finance and emerging market loan
Considerations in loan and bond markets clients who typically require much more time
2. Data requirements; A key consideration for certain sectors in the to make payments of interest and principal
loan and bond markets has been whether it payments, sometimes in excess of 30 days,
3. Similarity with the structure of Overnight is necessary to retain a forward-looking term and Islamic facilities that can pay variable
Index Swaps (OIS). structure in a RFR as an alternative to LIBOR. rates of return so long as the variable element
For example in sterling markets, SONIA is is pre-determined.
Proposals for a spread adjustment were an overnight rate and backward-looking,
measured against the following criteria: whereas some borrowers and lenders/ The message from the paper is that the use
investors have a preference for certainty of any TSRR should be limited and that where
1. Eliminating or minimising value transfer; of cash flow that can only be provided by possible market participants should use
a forward-looking measure. As RFRs are alternative rates.
2. Eliminating or minimising any potential backward-looking, the rate can only be
for manipulation; calculated near the end of an interest period In February 2020 the Bank of England
with a knock-on implication for systems and announced its intention to publish a daily
3. Eliminating or mitigating against the payment timings. compounding SONIA index from July 202040
impact of market disruption at the time to support the use of SONIA in a wide range
the fallback is applied. The RFRWG Term SONIA sub-working group, of financial products by simplifying the
and more recently the Term SONIA priority calculation of compounded SONIA fixings.
Even a simple change such as referencing task force, has looked into how a forward- A consultation was also issued seeking
daily compounding SONIA plus x bps instead looking rate can be constructed from SONIA views from sterling market participants on
of LIBOR may result in some value transfer and in July 2018 it launched a consultation the usefulness of publishing a simple set of
due to changes in market value following a on Term SONIA rates36. The consultation compounded SONIA period averages giving
change in the benchmark interest rate. acknowledges the need in some areas users easy access to SONIA interest rates,
of the market for a forward-looking Term compounded over a range of set time periods.
There may also be accounting and tax SONIA reference rate. In November 2018 a This followed a similar initiative from the New
issues, as many counterparties use LIBOR summary of responses to the consultation York Fed, which has been publishing Term
for derivative valuation purposes. Some were published37. SOFR rates since March 2020.
participants in the pensions Liability Driven
34
ISDA Consultation on Pre-cessation fallbacks
35
BCBS/IOSCO Press Release, 05 March 2019
36
BoE consultation on Term SONIA rates
37
Summary of responses to BoE Term SONIA consultation
38
Working Group on Sterling Risk Free Rate progress update
39
Use Cases of Benchmark Rates: Compounded in Arrears, Term Rate and Further Alternatives
40
Bank of England discussion paper daily SONIA compounded index and SONIA period averages
9LIBOR: the countdown to 2021
These initiatives are likely to benefit end users A number of firms (mostly banks) have issued
who are not familiar with calculating interest bonds referencing RFRs. To overcome cash
rates over a time period where the rate flow challenges, bond issuers have adopted
changes each day. mechanisms to smooth the settlement “The discontinuation
According to the latest RFRWG roadmap we
process. In SONIA referencing bonds we have
seen the Interest Determination Date set five
of LIBOR should not be
can expect to see the publication of available days in advance of the interest payment date, considered a remote
for use term SONIA reference rates during
Q3 2020.
enabling market participants sufficient time
for calculation of cash flow and settlement.
possibility” and “the
In the US, we have seen a slightly different biggest obstacle to a
Whilst there are now firmer plans for a sterling
TSRR, in his July 2019 speech41 the FCA’s
approach for bonds that reference SOFR.
Initially bonds have typically used a daily
smooth transition is inertia
Andrew Bailey said “I cannot guarantee averaging interest calculation method and – a hope that LIBOR will
that these efforts to produce term rates will lockout period, where instead of a lag, the
be successful, or the precise timing of their same interest rate fixing is assumed for the continue, or that work on
arrival” and cautioned that “we think that any final few days of the interest period (initially transition can be delayed
firms still delaying transition until term rates four days, or more recently, two days).
arrive are making a mistake”. At the present More recent SOFR issuances have utilised or ignored. Misplaced
time there are no definitive timelines for term the SONIA lookback method with coupons confidence is a risk to
risk free reference rates in other currencies. paid on a daily compounding basis. These
differing conventions in SONIA and SOFR financial stability as well as
In the US the ARRC published a User’s Guide
to SOFR, the document includes information
may still evolve and harmonise. A discussion
paper exploring these conventions for
to individual firms. ”
on a potential Term SOFR42. There are similar the sterling market and inviting feedback
term rate considerations underway in both was issued in March 201944 and in August
the EU and Japan. 2019 responses to the consultation were
published45. Similarly in the US, the ARRC has
In a positive development the first daily produced a number of papers including a
compounding SONIA loan was announced SOFR conventions guide. These materials can those which mature after 2021. This review
in June 2019 and since then we have seen a be found on the ARRC website46. It is worth could include the creation of an overall
small number of additional transactions. We noting that both the Bank of England and the inventory of products and systems used to
can expect to see further transactions during Fed’s proposals for an RFR index employ the capture such exposures. The official sector
2020 as firms work with system vendors to same compounding in arrears methodology, are encouraging firms to transition rather
upgrade loan booking platforms. which may foster convergence in terms of than rely on fallbacks, and if Term SONIA
international practices. is published (albeit for limited use cases)
A further consideration is if the swap market or the market adopts alternative solutions
changes in a different way to the loan and What next? (as seen in the bond markets) and once
bond markets, as this could give rise to basis In his July 2018 speech, Andrew Bailey said: the ISDA fallback process is complete, we
risk and volatility in P&L for hedge accounting “The discontinuation of LIBOR should not be expect transition to alternative benchmarks
packages. The International Accounting considered a remote possibility” and “the to accelerate. Firms should also pay close
Standards Board (IASB) is currently discussing biggest obstacle to a smooth transition is attention to the timeline47 published by the
recommended treatment for existing hedge inertia – a hope that LIBOR will continue, or RFRWG and also the revised target date
accounting. The Board recently approved that work on transition can be delayed or of Q1 2021 by which time GBP issuance of
recommendations to allow the continuance ignored. Misplaced confidence is a risk to LIBOR based Loan product with a maturity
of hedge accounting for LIBOR-linked financial stability as well as to individual firms.” date beyond 2021 has ceased. Following the
products, the latest update43 was provided in update on 29 April 2020 firms should also pay
January 2020. In the first instance, firms are encouraged attention to any further statements from the
to review existing LIBOR exposures and RFRWG on the impact of Coronavirus on the
fallbacks, paying particular attention to timeline for LIBOR transition plans.
41
Andrew Bailey speech LIBOR : preparing for the end
42
A User’s Guide to SOFR, April 2019
43
IBOR reform and its Effects on Financial Reporting – Phase 2
44
Discussion Paper: Conventions for referencing SONIA in new contracts
45
Summary from the Working Group and responses to the consultation
46
Alternative Reference Rates Committee (ARRC)
47
RFRWG 2020 Top Level Priorities and Roadmap
10LIBOR: the countdown to 2021
Phasing out LIBOR – timeline
UK
The Working Group One year after his National Express Interest
on Sterling Risk-Free first speech Andrew is first company to rate swap
Reference Rates Bailey reinforces LIBOR publically announce conventions
transition message No new Panel
(Sterling WG) it has entered into a change from
GBP Banks no
announces SONIA SONIA loan facility LIBOR to
LIBOR longer
as its preferred near SONIA
cash compelled
Risk Free Reference
products to submit
Rate (RFR) Sterling WG
beyond to LIBOR
EIB (Jun) and Lloyds publishes
2021
FCA CEO Bank (Sep) issue priorities and Revised Regulators
maturity
Andrew Bailey SONIA-linked bonds roadmap for ISDA 2006 expect
questions the 2020 Definitions Significant LIBOR to
sustainability PRA/FCA reduction cease
Sterling WG
of LIBOR in issue in stock of
publishes
speech to Dear CEO GBP LIBOR
report on SONIA
Bloomberg Letter contracts
compounded in
arrears and use
Reformed
cases
SONIA first
published by SONIA Term SONIA
BoE in April Rate test data Term
2018 Rate
available
SONIA futures for use
are traded
2017 2018 2019 2020 2021
SOFR
Panel Banks agree published
to continue LIBOR and SOFR
contributions until futures
start €STR
end 2021
to trade selected as
EUR RFR ISDA’s fallback for FCA and IBA Expected effective
IBORs agreed letters to ISDA date of amended
on pre-cessation 2006 ISDA
€STR published from
trigger definitions and
ISDA launches 2 October 2019.
related protocol
LIBOR designated consultation on EONIA set to €STR LCH consultation
a Critical pre-cessation + 8.5bps and will on pre-cessation
Benchmark under issues for LIBOR be published until trigger
EU Benchmark January 2022
Regulation (BMR)
ISDA launches EURIBOR added to the ESMA
consultation on benchmark register as BMR CME and LCH SOFR
fallbacks for IBORs compliant change derivative Term Rate
BMR amended to allow regulators to discounting from available
International compel submitters for up to 5 years LIBOR to SOFR for use
11LIBOR: the countdown to 2021
Glossary
ACT: Association of Corporate Treasurers FSB: Financial Stability Board LMA: Loan Market Association
BCBS: Basel Committee on Banking FSMA: Financial Services and Markets NWG: National Working Group
Supervision Authority
OIS: Overnight Indexed Swap
BOE: Bank of England G20: Group of 19 individual countries plus
OSSG: Official Sector Steering Group
the European Union
BMR: EU Benchmark Regulation
P&L: Profit and Loss
IBORs: Interbank Offered Rates
ECB: European Central Bank
PRA: Prudential Regulation Authority
ICE: Intercontinental Exchange
EONIA: Euro Overnight Index Average
RFR: Risk Free Reference Rate
ICE BA: ICE Benchmark Administration Ltd
ESMA: European Securities and
SARON: Swiss Average Rate Overnight
Markets Authority IOSCO: International Organization of
Securities Commissions SOFR: Secured Overnight Financing Rate
€STR: Euro Short-term Rate
ISDA: International Swaps and Derivatives SONIA: Sterling Overnight Index Average
EURIBOR: Euro Interbank Offered Rate
Association TONAR: Tokyo Overnight Average Rate
FCA: Financial Conduct Authority
LDI: Liability Driven Investment TSRR: Term SONIA Reference Rate
FRNs: Floating Rate Notes
LIBOR: London Interbank Offered Rate
CONTRIBUTORS
STEVE BULLOCK
Head of Benchmark Submission and
Supervision, Group Corporate Treasury
Lloyds Bank
E: steve.bullock@lloydsbanking.com
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