LIBOR cessation: demystifying the switch to risk-free rates

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This article was written by Dale Rayner and Jenny Zhao, with thanks to Alix Prentice, Richard Mazzochi, Jessie Chong and Helena Busljeta for their research and contributions.

It's official.

On 5 March 2021 the UK Financial Conduct Authority (FCA) announced[1] that all LIBOR settings will either cease to be published by any administrator or will no longer be representative at specified future dates, with a clear message to market participants: "act now and complete your transition by the end of 2021."  See our recommended "dates to diarise" below.

Market participants should consider whether FCA's latest announcement constitutes a pre-cessation or cessation trigger under their LIBOR-linked contracts.  Where parties have incorporated Asia Pacific Loan Market Association (APLMA) or Loan Market Association (LMA) rate switch language in their contracts, the FCA announcement will likely (though not in all cases) constitute a "Rate Switch Trigger Event" for a rate switch currency.  This means that the rate will switch to an RFR on the date on which the relevant LIBOR rate for the quoted tenor ceases to be published or otherwise becomes unavailable (or on any earlier date specified in the documents).  Agents for syndicated lenders should be aware that certain notification obligations may have already been triggered under the contracts they manage.

The International Swaps & Derivatives Association (ISDA) has also confirmed[2] that the FCA announcement is an index cessation event under the LIBOR 2020 IBOR Fallbacks Protocol (the "Protocol").  As a result, the FCA announcement has locked in Bloomberg's fallback spread calculations for all Sterling, USD, Euro, Swiss Franc and JPY LIBOR settings.  For clients who already adhere to the Protocol, their ISDA contracts will transition automatically to replacement rates when LIBOR ends. 

With the clock now ticking louder towards the end of LIBOR, even the most reluctant observers are now aware that the question is no longer 'whether' or 'when', but 'how' to manage the transition.

In this digest, we provide an overview of what benchmark reform is, why this matters and what you should be doing to prepare your business. 

Why is everyone talking about LIBOR?

The London Interbank Offered Rate (LIBOR) is a benchmark for short-term interest rates, currently administered by the Intercontinental Exchange (ICE).  LIBOR is amongst the most widely used benchmark rate for calculating interest rates for derivatives, bonds and loans as well as a range of consumer lending products such as mortgages and student loans.  It is also used as a gauge of market expectations regarding central bank interest rates, liquidity premiums in the money markets and an indicator of the health of the banking system.  Other interbank rates are set for other currencies and jurisdictions, including EURIBOR, BBSW and HIBOR in financial centres such as Luxembourg, Sydney and Hongkong.

In setting the interbank rate, administrators rely on pricing submissions from a panel of international banks.  Following the global financial crisis in 2007- 2008, there has been increased global scrutiny on the integrity of the benchmark rate setting process, and the LIBOR scandal in 2014 only served to amplify calls for reform.  In July 2014, the Financial Stability Board recommended a transition towards risk free rates (RFRs), ideally grounded in actual transactions and liquid markets rather than derived from a poll of selected banks.  Andrew Bailey, the then-CEO of FCA set the gears in motion in July 2017, when he announced plans for the publication of LIBOR to cease after 2021. 

Where are we now in relation to Sterling and USD LIBOR?

The global transition towards risk-free rates has slowly but surely gathered momentum, with industry and regulator discourse peaking in the past two years.  Most market participants are now familiar with the notion that Sterling LIBOR and USD LIBOR will soon be replaced by the Sterling Overnight Index Average (SONIA) and Secured Overnight Financing Rate (SOFR), respectively.  

We have set out below some key dates to diarise, including LIBOR cessation dates confirmed by the FCA on 5 March 2021.  Existing LIBOR contracts which have not transitioned by the applicable cessation date may become subject to "tough legacy" proposals (see What are "tough legacy" proposals and will they apply to me?). 

Dates to diarise for Sterling LIBOR to SONIA transition

  • After 31 March 2021:
    • No new Sterling LIBOR-linked loans, bonds, securitisations and linear derivatives (other than for risk management of existing positions) maturing after 2021.
    • All legacy Sterling LIBOR-linked contracts to be identified.
  • After 30 September 2021: All legacy Sterling LIBOR-linked contracts to contain contractual arrangements to facilitate the switch to an RFR either through pre-agreed rate switch provisions or provisions setting out an agreed process for negotiation; and
  • After 31 December 2021: Sterling LIBOR will cease to be published and all Sterling LIBOR-linked contracts must transition to replacement RFRs.*

* The FCA will consult on requiring the continued publication of 1, 3 and 6 month Sterling LIBOR settings on a non-representative, synthetic basis for a further period following cessation, pursuant to its "tough legacy" powers.  See What are "tough legacy" proposals and will they apply to me?

Dates to diarise for USD LIBOR to SOFR transition

  • After 30 June 2021: No new USD LIBOR-linked contracts - ARRC recommended date..
  • After 31 December 2021: No new USD LIBOR linked contracts to be entered  into by banks - Federal Reserve System and other banking agencies specified date.1 week, 2 month tenors for USD LIBOR will cease to be published and all USD LIBOR-linked contracts must transition to replacement RFRs.**
  • After 30 June 2023: Remaining USD LIBOR tenors will cease to be published, and all remaining USD LIBOR-linked contracts must transition to replacement RFRs.***

**Whilst key USD LIBOR tenors (1, 3, 6 and 12 month settings) will continue to be published until June 2023, the NY Fed has warned that continued publication will be for the limited purpose of assisting with run-off of legacy contracts only.  Lenders are expected take a proactive approach towards switching from USD LIBOR benchmark to SOFR (or other alternative RFRs) prior to June 2023.  Reduced liquidity from increased movement away from LIBOR may also mean that the ICE rates will no longer reflect the underlying markets and rates.

***The FCA will consider whether to require IBA to continue publishing of the 1-month, 3-month and 6-month US dollar LIBOR settings on a non-representative synthetic basis for a further period after the end of June 2023.

RFRs across currencies and the world

RFRs are not the only alternative to LIBOR — for example RFRs may not be appropriate for small corporate loans, trade finance and Islamic finance.  However, for the broader market, 5 key alternative RFRs have been designated to replace LIBOR for the 5 LIBOR currencies by national working groups ("National Working Groups") established in the LIBOR currency jurisdictions.  They are summarised below.

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