LIBOR Transition A practical guide · Alternative Reference Rates (ARRs) for the five major...
Transcript of LIBOR Transition A practical guide · Alternative Reference Rates (ARRs) for the five major...
SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.2 - PA BIB.docx
August, 2020 1
LIBOR Transition
A practical guide
August 2020 Edition
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Table of Contents
LIBOR Transition __________________________________________________________________________________ 1
A practical guide _________________________________________________________________________________ 1
August 2020 Edition ______________________________________________________________________________ 1
1. LIBOR Transition: Executive Summary __________________________________________________ 4
What does this document seek to do? _________________________________________________ 4
Summary _________________________________________________________________________ 4
Practical considerations checklist ______________________________________________________ 4
Key highlights _____________________________________________________________________ 4
What's next? ______________________________________________________________________ 4
2. LIBOR Transition: Facts and Figures ____________________________________________________ 5
What is LIBOR? ____________________________________________________________________ 5
Where is LIBOR used? _______________________________________________________________ 5
What is happening to LIBOR and by when? _____________________________________________ 5
What has the response been to date? __________________________________________________ 5
What are the main Alternative Reference Rates? _________________________________________ 6
How do these ARRs differ to LIBOR? ___________________________________________________ 7
Are these ARRs secured or unsecured? _________________________________________________ 7
Will the ARRs have forward looking term structures? _____________________________________ 7
What are ARR Compounded Index Rates? ______________________________________________ 7
What about the other IBOR benchmark Rates? __________________________________________ 7
Summary and Practical Considerations _________________________________________________ 8
3. LIBOR Transition: Discounting Risk _____________________________________________________ 9
What is discounting risk? ____________________________________________________________ 9
What are the implications for CSAs? ___________________________________________________ 9
How are the CCPs approaching the change? ____________________________________________ 9
Why will these changes drive an increased Bilateral Negotiation of CSAs? ___________________ 10
When will UBS be ready to open CSA negotiations? _____________________________________ 10
What is the impact on swaption contracts? ____________________________________________ 10
What is the UBS current stance on swaption voluntary compensation? _____________________ 10
Summary and Practical Considerations ________________________________________________ 11
4. LIBOR Transition: Forecasting Risk ____________________________________________________ 12
What is Forecasting Risk? ___________________________________________________________ 12
What are the Fallback Provisions? ____________________________________________________ 12
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What are some examples of differing fallback methods? _________________________________ 13
How will the LIBOR transition affect contracts executed under the updated Definitions? _______ 13
How will the LIBOR transition affect the existing contracts? _______________________________ 13
What is expected to happen to cleared contracts? ______________________________________ 13
How will the LIBOR transition affect products other than OTC derivatives? __________________ 14
How could hedge effectiveness across asset classes via linked transactions be affected by the LIBOR transition? _______________________________________________________________________ 14
What is the ISDA LIBOR to ARR adjustment? ___________________________________________ 14
What are the ARRC's recommended best practices? _____________________________________ 14
What is Pre-Cessation? _____________________________________________________________ 15
What is 'Synthetic LIBOR'? __________________________________________________________ 15
What are the implications of 'Synthetic LIBOR' on Transition? _____________________________ 15
What has been the reaction to the HM Treasury announcement so far? ____________________ 16
Why is the Transition challenging for certain products? __________________________________ 16
Why might these Forecasting Risk changes drive increased bilateral/ multilateral negotiation? __ 16
What are the main drivers that may determine the impact on Forecasting Risk? ______________ 16
Summary and Practical Considerations ________________________________________________ 17
5. From 2017 to Date: Regulatory and Market Milestones ______________________________ 18
6. Upcoming Regulatory and Market Milestones ______________________________________ 19
7. Appendix _______________________________________________________________________ 20
From 2017 to Date: Regulatory and Market Milestones __________________________________ 20
Upcoming Regulatory and Market Milestones __________________________________________ 23
Other IBORs Benchmark Rates _______________________________________________________ 26
Overnight Index Swap Industry Definitions _____________________________________________ 27
ARR detailed information ___________________________________________________________ 27
8. Bibliography ____________________________________________________________________ 28
9. Glossary ________________________________________________________________________ 29
10. Disclaimer _______________________________________________________________________ 30
11. Contact information _____________________________________________________________ 31
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1. LIBOR Transition: Executive Summary
What does this document seek to do?
This guide aims to give UBS clients an understanding of the LIBOR transition and highlights the practical considerations that should be taken into account. This communication is not sent to you in connection with any wealth management, corporate or institutional client or asset management relationship you may have with UBS.
Summary
Regulators have announced that by the end of 2021 the market should stop relying on LIBOR. Each of the Alternative Reference Rates (ARRs) for the five major currencies (USD, EUR, GBP, CHF, JPY) involved is at a different stage in terms of development and liquidity. In due course other currencies' alternative rates may be developed but the initial focus has been on these five. The industry needs to understand, prepare and execute with respect to this market change.
LIBOR is used as a reference rate in a multitude of products and links, for example between a derivative and an underlying asset, need to be considered in order to understand potential basis risk between LIBOR and the new ARR. In addition to migration of transactions, industry changes in discounting methodology are planned and changes in technology systems may be required.
UBS aims to keep clients informed of these changes and is running an extensive internal change programme focussed on this transition. Note that EURIBOR and TIBOR are expected to remain into medium term so industry focus is on the other rates.
Practical considerations checklist
Understand what this change means for you:
– Analyse the exposure you currently have to LIBOR and assess the potential financial impact
– Ensure you know where you have transactions which you believe to be linked (see Forecasting Risk Section)
– Review the fallback language in your Legal Documentation (see Forecasting Risk Section)
Review your readiness:
– Evaluate whether you need to make any changes to your risk management systems
– In addition, consider any operational processes you may need to update, for example ensuring all reference data sources are updated accordingly
– Consider consolidating your LIBOR exposure to reduce the number of bi-lateral transitions required
Key highlights Facts and Figures Discounting Risk Forecasting Risk
5 ARRs have been identified to replace the 5 LIBOR currencies
Each ARR is an overnight rate
The ARRs are backward looking rates
Adjustment methodology
agreed to address the differences (term and credit) between LIBOR and ARRs.
Discounting rate and interest paid on collateral usually aligned
Switch in discounting rates to
ARRs by CCPs is likely to be a key driver for increased adoption of ARRs across the industry
Any changes to the margin annex
for a derivative contract should reference the new ARR to replace existing cash margin rate
Updated ISDA Definitions due to be published in Q3 2020
Differences in fallback methodology
across different product types may impact hedge effectiveness across transactions believed to be linked
Evaluation of current contractual fallback provisions may lead to increased bilateral discussion
What's next?
When relevant, UBS will be contacting you in due course on the following topics:
Trades with UBS referencing LIBOR;
Contracts with UBS which reference a transitioning benchmark.
If you have any further questions, in the first instance please contact your sales representative. Alternatively, please get in touch via [email protected].
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2. LIBOR Transition: Facts and Figures
What is LIBOR?
The London Interbank Offered Rate (LIBOR) is calculated from submissions by selected "panel" banks1 of the rates they either pay or would expect to pay to borrow from one another.
LIBOR is a widely-used interest rate benchmark. Rates are determined daily by the LIBOR administrator, the ICE Benchmark Administration (IBA), for various currencies (USD, EUR, GBP, CHF, JPY) and tenors (Overnight, 1w, 1m, 2m, 3m, 6m and 12m).
Where is LIBOR used?
According to IBA, LIBOR is used to determine periodic interest payments for many hundreds of trillions of notional of financial products globally, and is used for example in derivatives, bonds, structured products, securitised products and loans.
What is happening to LIBOR and by when?
Just over a decade ago, the market's perception of an increase in inter-bank credit risk inherently contained within LIBOR led to a widening of the basis between LIBOR and short-term interest rate futures. Financial institutions began to switch from using LIBOR to Overnight Index Swap rate (OIS) for discounting purposes, which was seen as being closer to a risk-free rate. At the same time, liquidity in the unsecured lending market, which underpins LIBOR, declined as banks became increasingly unwilling to lend to one another on an unsecured basis. The concern was that a lending rate, based on an increasingly less liquid market, was being used to reference many multiples of financial contracts. As a result, in 2017, the FCA announced that the market should transition to alternative reference rates based firmly on transactions, with panel bank support for current LIBOR agreed only until the end of 2021.
The end-2021 deadline has been reiterated by regulatory bodies around the world and, despite market-driven transition challenges triggered by the COVID-19 pandemic, the FCA2 has stated that the transition away from LIBOR still needs to happen by the end of 2021.
What has the response been to date?
In response to these concerns on LIBOR, the Financial Stability Board's (FSB) review produced the basis for the 19 principles developed by the International Organization of Securities Commissions (IOSCO) 3. One of the key IOSCO
1 https://www.theice.com/iba/libor#methodology
2 https://www.fca.org.uk/news/statements/impact-coronavirus-firms-libor-transition-plans
3 https://www.iosco.org/library/pubdocs/pdf/IOSCOPD415.pdf
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principles was that a new "representative" benchmark reference rate should wherever possible be based on transactions and not expert judgement.
Since the initial FCA statement in 20174, national working groups (see Forecasting Risk section) have been set up with the support of regulators and central banks with broad industry and market representation. These working groups have recommended alternative benchmarks for each of the LIBOR currencies. These alternatives are viewed as more robust benchmarks, compliant with IOSCO principles and are underpinned by larger volumes of observable transactions.
What are the main Alternative Reference Rates?
Different jurisdictions have developed different methodologies for their new ARRs, and as illustrated in the timelines in the appendix, these are all at different stages in terms of market liquidity and development. These ARRs are managed by different administrators, as outlined below.
Jurisdiction Working Group
Legacy Reference Rate Target ARR
Underlying transactions
Secured vs Unsecured
Rate Administrator Comments
US Alternative Reference Rates committee (ARRC)
USD LIBOR Secured Overnight Financing Rate (SOFR)
Secured Federal Reserve Bank of New York
UK Working group on Sterling Risk-Free Reference Rates
GBP LIBOR Sterling Overnight Index Average (SONIA)
Unsecured Bank of England
Euro Area Working Group on euro risk-free rates
EONIA1 Euro Short Term Rate (€STR)
Unsecured European Central Bank
Reformed EURIBOR is expected to continue alongside €STR as a multiple rate approach. The European Commission has expressed confidence in EURIBOR for the medium term
Switzerland The National Working Group on Swiss Franc Reference Rates
CHF LIBOR Swiss Average Rate Overnight (SARON)
Secured SIX Swiss Exchange
Japan Study Group on Risk-Free Reference Rates
JPY LIBOR Tokyo Overnight Average Rate (TONA)
Unsecured Bank of Japan Multi rate approach planned with TIBOR (but Euroyen TIBOR may discontinue)
Note:
1 This is not an IBOR, however it is being replaced by an ARR. EUR LIBOR has not been referenced as its role as a benchmark is dwarfed by the
use of EONIA or EURIBOR.
Please see the Appendix for ARR detailed Information.
4 https://www.fca.org.uk/news/speeches/the-future-of-libor
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How do these ARRs differ to LIBOR?
The ARRs are structurally different from LIBOR and are not economic equivalents.
Components LIBOR ARRs
Methodology Based on a waterfall methodology incorporating real transactions but also expert judgement
SOFR, SONIA, €STR, SARON and TONA are anchored in real transactions
Term Published for 7 maturities from overnight up to one year
Currently only available overnight
Credit Risk
Adjustment
Includes a risk adjustment to account for
interbank credit spread and tenor
There is minimal credit spread adjustment as the
ARRs are overnight rates and some ARRs are secured
Rate The rate is set at the beginning of the period The rate is based on daily observations and is
only known at the end of the period
Settlement Conventions
Paid at end of period There are a variety of conventions used in the calculation of cashflows dependent on backward looking rates:
Compounding of the overnight ARR over the
payment period
Averaging of the overnight ARR over the
payment period
Lockout
Backward Shift or Lookback
Please see Appendix Overnight Index Swap
Industry Definitions for further information on
the above
These differences may mean your risk management systems may require enhancements to manage the different methodology of curve construction.
Are these ARRs secured or unsecured?
Some of the ARRs are secured rates, i.e. calculated from observed repos collateralized by government bonds. This applies to SARON for CHF and SOFR for USD. The others are unsecured like LIBOR, i.e. based on unsecured borrowing with no actual underlying security. LIBOR differs from these unsecured ARRs in that it is based not only on observed interbank borrowing transactions but also expert judgement.
Will the ARRs have forward looking term structures?
The ARRs developed to date are overnight rates. There are several ongoing efforts by the ARR working groups looking to develop forward looking term structures for the ARRs (except for SARON). However, a forward looking term rate requires sufficient depth in the ARR derivatives market in order to be able to calculate the rate, so they may not be fully available for use by 2021.
What are ARR Compounded Index Rates?
An alternative to forward looking term structures is to provide the result of compounding a rate over a period (such as 30, 90, 180 days) and publishing these as indices. This may assist some market participants to adopt these rates as it can limit the amount of daily compounding calculations required.
In March 2020 both the Federal Reserve and SIX began publishing 30-, 90-, and 180-day SOFR averages (as well as a SOFR Index) and 1-, 3- and 6-month compounded SARON indices, (calculated in arrears) respectively. Such compounded indices for SONIA have been published by Bank Of England from 3rd August 2020.
What about the other IBOR benchmark Rates?
The initial focus has been on the five ARRs detailed above. In due course other alternative rates may be developed. See appendix Other IBORs Benchmark Rates for selected examples of those currently under review.
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Summary and Practical Considerations
Below are some of the practical considerations clients should take into consideration for this LIBOR transition
Summary Practical Considerations include
5 ARRs have been identified to replace the 5 LIBOR
currencies
Evaluate whether you need to make any changes to
your risk management systems, specifically to ensure
that you are able to trade, manage and settle
transactions referencing a backward looking
compounded (or simple averaged) rate as opposed
to a forward looking term rate
The ARRs are currently only overnight rates
The ARRs are generally published the following day
The methodology to calculate an adjustment to
replace LIBOR with an ARR (to address the term and
credit differences) has been agreed by ISDA
If you have any further questions, in the first instance please contact your sales representative. Alternatively,
please get in touch via [email protected].
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3. LIBOR Transition: Discounting Risk
What is discounting risk?
The derivative contracts portion of the hundreds of $trillions of contracts are held in portfolios of trades that were either executed bilaterally between market participants (under ISDAs and if collateralized with a Credit Support Annex (CSA)) or intermediated by Central Clearing Counterparties (CCPs). Many of these bilateral CSAs reference Effective Federal Funds Rate (EFFR) or EONIA as the benchmark used to determine the interest paid on cash collateral posted. The CCPs currently use EFFR to determine the margin interest rate (known as Price Aligned Interest5 (PAI) rate) for USD activity (and prior to a switch to €STR in late July 2020 used EONIA for PAI for EUR.
Whilst the expected value of LIBOR drives the expected payments referencing LIBOR, the cashflows themselves need to be discounted back to the present value / price for a contract or security respectively. In this case, the change in the discounting curve on the valuation is referred to as Discounting Risk. Prior to the financial crisis, in the derivatives market, the rate used to discount these cashflows was LIBOR. Subsequently many market participants adopted an approach that aligned the discounting rate used with the interest rate paid (cash margin rate) on the type(s) of collateral specified (known as Eligible Collateral) in the underlying CSA. Any change in the discounting curve will not only change the Discounting Risk but also create a value transfer.
What are the implications for CSAs?
To reflect the eligible collateral, the current overnight benchmarks for the major currencies are used to pay PAI. For example the EFFR is used as the PAI rate on the posting of USD cash collateral. This rate is generally used as the discount rate to value the trade. Similarly, when it comes to posting of EUR cash collateral, EONIA is the PAI rate and the discount rate. EMMI has announced that EONIA will be withdrawn at end of the 2021. CSAs referencing this rate can be updated before that date, for example, by replacing with €STR.
For CSAs where non cash collateral is used, e.g. government bonds, margin interest is not transferred between counterparties, therefore there is no need for any renegotiation to change the discounting rate used to value the trade. The discounting rate used to value the underlying derivative contracts of these CSAs is aligned to the funding rate for this collateral in the secured funding market. As an example, if US Treasuries are the only eligible collateral, this could currently mean that the discount rate used is EFFR for the CSA. This rate could change to SOFR once the secured funding market adopts SOFR as the funding rate instead of EFFR.
The CSA changes are likely to accelerate post the switch from EFFR to SOFR and from EONIA to €STR when the CCPs make the change in 2020. The switch in discounting rates is a significant milestone for LIBOR transition as it is expected that market participants will look to switch their discounting risk thereby establishing hedging and re-hedging requirements in transactions referencing these ARRs: a key driver for adoption of ARRs as the market standard floating rate.
How are the CCPs approaching the change?
LCH and CME have disclosed their plans to adopt SOFR in place of EFFR as the PAI rate and discounting rate for all USD discounted contracts held in the exchange. In order to minimize the resulting discounting risk basis, it is expected that some market participants will seek to renegotiate their CSAs referencing EFFR to SOFR as close as possible to the CCP timelines. For details on the switch from EFFR to SOFR as the PAI rate and discounting of USD activity at LCH and CME, please see the table below:
5 https://www.theotcspace.com/content/price-alignment-interest-pai
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EFFR->SOFR LCH6 CME7
Date of Change
16th October 2020 16th October 2020
Scope All USD discounted products All USD discounted products
Proposal
Summary Cash and Risk compensating
(EFFR/SOFR Basis) swaps for Members
Clients can opt for Cash only & an
auction process will take place to ensure LCH remains flat risk/cash
All Participants take Cash and Risk compensating
(EFFR/SOFR Basis) swaps
OR
For participants that do not want Basis swaps,
CME intends to engage third party providers to facilitate an auction and/or transfer mechanism
As of 27th July 2020, €STR replaced EONIA as the PAI rate and discounting rate for all EUR discounted contracts held EUREX, CME and LCH. As the spread between EONIA and €STR is fixed at 8.5bps, only announced cash compensation was transferred.
Why will these changes drive an increased Bilateral Negotiation of CSAs?
In addition to the negotiations mandated by the "Margin requirements for non-centrally cleared derivatives" regulations8 (with the first phase effective 1st September 2016 and final phase due 1st September 2021), CSA renegotiations driven by LIBOR transition are expected to be a major exercise. Given the majority of OTC contracts referencing LIBOR are cleared, there is an expectation that market participants may want to ensure that both current regulatory mandated and non-mandated bilateral CSAs are in line with CCP discounting and PAI. The industry has largely been through the transition from using LIBOR to overnight rates for discounting. The expectation is that the transition from current overnight rates (EONIA, EFFR) to ARRs (€STR, SOFR) will not be as challenging as the transition from LIBOR to ARR for forecasting. Forecasting changes will be discussed in the next section.
When will UBS be ready to open CSA negotiations?
UBS commences CSA negotiations after the current CCP transition dates. For CSAs currently referencing EONIA, UBS opened negotiations to effect the change of PAI to €STR at the end of July 2020. Similarly once the switch from EFFR to SOFR is completed at the CCPs on the 16th October 2020, UBS aims to open CSA negotiations for those CSAs referencing EFFR. Please contact your Sales representative directly to start the process.
What is the impact on swaption contracts?
The change in CCPs’ PAI for cleared swaps has a corresponding impact on swaptions that reference the price of cleared swaps as the underlying instruments. Depending on the extent to which the swaption is in or out of money changes following on from switch in PAI benchmark, either party of the swaption contract may experience a significant windfall gain or loss.
In order to recompense market participants for a windfall gain or loss in the price of a swaption due to the change in the underlying price of cleared swap, both the ECB9 and ARRC10 recommended that market participants should exchange voluntary compensation with their swaption counterparties.
What is the UBS current stance on swaption voluntary compensation?
UBS agrees in principle with the ARRC's recommendation for industry-wide compensation for the legacy swaption contracts affected by the discounting transition from EFFR to SOFR and would support an industry-wide implementation of a process which ensures that the payment of compensation is widespread and includes counterparties both with net compensation payments and receipts. We are not yet aware of industry formal working group discussions taking place to determine the mechanics of implementing the Committee's recommendation, and note that voluntary compensation was not possible in the transition from EONIA to ESTR,
6 https://www.cftc.gov/media/2421/MRAC_LCHSOFRDiscountingLetter090919/download
7 https://www.cmegroup.com/education/articles-and-reports/sofr-price-alignment-and-discounting-proposal.html
8 https://www.bis.org/bcbs/publ/d475.htm
9 https://www.ecb.europa.eu/pub/pdf/other/ecb.recommendation_swaptions_impacted_by_discounting_switch_to_EuroSTR~a64f042ed9.en.pdf
10 https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-swaptions-recommendations.pdf
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however continue to speak to regulators and ISDA on this. If you wish to share your views on the matter, please contact your sales representative or alternatively, get in touch via [email protected].
Summary and Practical Considerations Below are some of the practical considerations clients should take into consideration for this LIBOR transition
Summary Practical Considerations include
Discounting rate and interest paid on cash collateral
usually aligned
Review eligible collateral terms in your CSAs
(specifically cash interest rate on margin)
Assess the economic impact of switching your
interest rates
Switch in discounting rates to ARRs by CCPs is likely
to be a key driver for increased adoption of ARRs
across the industry
Be mindful that once CCP switches are made, basis
risk may exist between your cleared and bilateral
portfolios
Consider which CSAs you may need to prioritize
renegotiation for in order to reduce this potential
basis risk
Any changes to the margin annex for a derivative
contract should reference the new ARR to replace
existing cash margin rate.
A change to the cash margin rate in the agreement
will result in a change in margin interest flows and
potentially the discounting curve used for the
underlying derivative portfolio
Consider there may be a value transfer with your
bilateral counterpart for this change that will need to
be agreed
If you have any further questions, in the first instance please contact your sales representative. Alternatively, please
get in touch via [email protected].
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4. LIBOR Transition: Forecasting Risk
What is Forecasting Risk?
LIBOR is widely applied as the floating interest rate benchmark referenced in a derivative (such as a swap floating leg), coupon on a bond or used to determine the interest rate on a loan. The valuation of such contracts or securities is driven by the change in the expected value of LIBOR—this is expressed as Forecasting Risk.
Active LIBOR transition is where market participants switch out of LIBOR referenced contracts into ARR referenced contracts as market liquidity allows, rather than waiting until the end of 2021. This activity would see ARR forecasting risk gradually replace LIBOR forecasting risk.
The ARR forecasting curve is generally lower than the LIBOR equivalent.
What are the Fallback Provisions?
For any contracts referencing LIBOR when it is discontinued, the parties will, in the absence of changes to the terms, have to rely on the contractual terms that exist to determine the post-cessation rate. The effectiveness and prevalence of these fallback provisions varies across products and markets. These provisions, depending on when drafted, may have the components listed in the following table. Market participants should review existing derivative contracts and current positions in all LIBOR-referencing financial contracts (that expect to be held beyond 2021) for provisions that determine the reference rate in the absence of LIBOR, or confirm the steps to be taken to frame an alternative. Various groups (specifically ISDA for derivative contracts) are coordinating inputs from the industry to arrive at fallback language for impacted financial products addressing permanent LIBOR cessation.
Term Definition
Fallback
Language
Fallback language refers to the legal provisions in a contract that apply if the underlying
reference rate (e.g. LIBOR) in the product is not published (whether on a temporary or permanent basis).
Fallback Rate The reference rate replacing LIBOR upon the Fallback Trigger Event. There are multiple approaches adopted in existing contracts to calculate a fallback rate, including replacing a floating rate with the last LIBOR setting for all post-cessation fixings or referencing the lenders' costs of funds.
Spread Adjustment
As noted LIBOR is different to the ARR applicable in each jurisdiction and there may need to be a spread adjustment applied to the ARR replacing LIBOR to account for differences in the construction of LIBOR and the ARR.
Fallback Trigger Event
Set of events relating to the original reference rate which may trigger the fallback to a new Reference Rate.
Clients should consider the economic and financial impact of the fallback provisions in their own contracts.
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For example, the Federal Reserve Bank of New York's Alternative Reference Rate Committee has published language for cash products like securitized products and loans. The Loan Market Association has also focused on fallbacks for loans. ISDA is due to publish an update to its definitional booklets which incorporate updated fallback language (known as the IBOR fallback) in Q3 2020.
The preference of the FCA11 is for market participants to pro-actively switch to new alternative ARRs as soon as possible (as a primary approach), rather than to rely on fallback language (acting, in effect as a ‘seatbelt’). However, there are various aspects which may hinder this process—for example liquidity in an ARR.
What are some examples of differing fallback methods?
There are different defined triggers and fallbacks for different products. In bonds, for example, a common fallback in existing documentation is to use the last available published rate. Thus in the event of LIBOR cessation, these securities would essentially become fixed rate products. In loans, a common ultimate fallback is to lenders' costs of funds. In a derivative, on the other hand, the alternative to LIBOR may be subject to calculation by agents (e.g. a dealer poll undertaken by calculation agent or to some other method).
How will the LIBOR transition affect contracts executed under the updated Definitions?
For OTC derivatives, ISDA has consulted widely on updated Definitions to incorporate fallback language for implementation in derivative contracts, with the final form due Q3 2020.These changes will become effective for new contracts traded four months after the publication date. These updated Definitions will include pre-defined ARR based fallbacks for LIBOR and certain IBOR replacement rates and new trigger definitions.
An alternative approach may be to implement ISDA's Benchmark Supplement12, which sets out a contractual process aiming to agree an alternative rate, but does not pre-define the actual rate. The Benchmark Supplement does not therefore provide economic certainty.
How will the LIBOR transition affect the existing contracts?
ISDA is currently scheduled to publish an IBOR Fallback Protocol in Q3 2020 that when adhered to by market participants, will apply the updated Definitions to existing derivative contracts. The ISDA Protocol is expected to be drafted deliberately broad to cover transactions governed by ISDA Master Agreement or other forms of master agreement (e.g. Federation Bancaire Francaise, Swiss Master Agreement).
If market participants choose not to sign up to protocol or do not adopt the provisions through a bilateral negotiation then the existing contracts will remain on the current fallback provisions as stipulated in the contract which when written probably did not envisage a permanent cessation of LIBOR.
ISDA's Benchmark Supplement also provides the option to implement a contractual process for existing contracts. However, both parties to the contract need to elect to implement for existing contracts for this to take effect.
It is expected that regulated entities such as UBS would adhere to the protocol within 3-4 months of its publication.
It should be noted that even in ARRs where liquidity and volumes are most developed (i.e. SONIA), this is concentrated in linear derivatives such as swaps. For non-linear derivative contracts there is comparatively little liquidity and volumes currently e.g.in swaptions where an outright SONIA volatility surface has not yet developed. With respect to the ISDA IBOR Fallback protocol, reliance on this to achieve LIBOR transition may not provide the same level of economic certainty for non-linear derivative contracts that it does for linear derivatives. In a transaction, the replacement of LIBOR references with an ARR plus an adjustment spread may affect the moneyness of the transaction and affect its efficacy relative to when originally traded as a LIBOR referencing derivative.
What is expected to happen to cleared contracts?
CCPs have indicated they will look to apply the updated ISDA Definitions for all contracts (new contracts executed under updated Definitions as well as existing contracts)13.
11 https://www.fca.org.uk/news/speeches/libor-preparing-end
12 https://www.isda.org/book/isda-benchmarks-supplement/
13 https://www.isda.org/a/md6ME/FINAL-Pre-cessation-issues-Consultation.pdf
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How will the LIBOR transition affect products other than OTC derivatives?
It is hoped that products other than OTC derivatives referencing LIBOR may also include fallback language or other provisions aimed at easing the transition to the relevant replacement rate as and when industry standards develop.
How could hedge effectiveness across asset classes via linked transactions be affected by the LIBOR transition?
Differences in fallback methodology across different product types have added more complexity to the transition for linked transactions. For example the hedge effectiveness of a swap hedging the LIBOR component of a bond or loan may lose some efficacy upon the triggering of differing fallback methodologies. Market participants may need to discuss any linked or hedged transactions and evaluate contractual fallbacks in place. The market uncertainty in entering into new contracts referencing LIBOR beyond 2021 are summarized by the Commodities, Futures Trading Commission (CFTC)14.
What is the ISDA LIBOR to ARR adjustment?
ISDA has consulted with the industry to determine a market consensus on the methodology used to calculate the adjustment spread to address the term and credit differences between LIBOR and the ARR and other factors such as liquidity and fluctuations in supply and demand.
These consultations15 have established that market participants prefer to use the compounded setting in arrears rate to address differences in tenor between IBORs and overnight RFRs, and the historical median over a five-year lookback period approach.
Note that Bloomberg has begun to publish these LIBOR fallback rates as per ISDA's agreed methodology as of 21st July 2020. The real time data can be accessed via FBAK <GO> on Bloomberg Terminals, and is publicly available on the Bloomberg website on a delayed basis.
What are the ARRC's recommended best practices?
ARRC published its best practices16 for completing transition from LIBOR to provide date-based guidance, including when no new LIBOR activity should be conducted.
Product Hardwired Fallbacks Incorporated by
IT/Operational
Vendor
Readiness
Target for No New USD LIBOR (maturing beyond 2021)
Anticipated Fallback Rates to be selected by
Floating Rate
Notes
30th June 2020 30th June 2020 31st Dec 2020 6 months before the first reset/fixing scheduled after
LIBOR cessation
Business Loans 30th Sept 2020 30th Sept 2020 30th June 2021 6 months before the first reset/fixing scheduled after
LIBOR cessation
Consumer Loans Mortgages:
30th June 2020
Student Loans: 30th Sept 2020
Mortgages:
30th Sept 2020
Mortgages:
30th Sept 2020
Specific consumer regulations
Securitizations 30th June 2020 31st Dec 2020 CLOs: 30th Sept 2021
Other: 30th June 2021
6 months before the first reset/fixing scheduled after
LIBOR cessation
14 https://www.cftc.gov/media/2491/MRAC_IBORDisclosures090919/download.
15 https://www.isda.org/a/WhXTE/Adoption-of-Risk-Free-Rates-Major-Developments-in-2020.pdf
16 https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-Best-Practices.pdf
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Product Hardwired Fallbacks Incorporated by
IT/Operational
Vendor
Readiness
Target for No New USD LIBOR (maturing beyond 2021)
Anticipated Fallback Rates to be selected by
Derivatives Up to 4months after IBOR ISDA Protocol and New definition are published
Dealers to act to deliver a liquid
SOFR derivatives
markets to clients
30th June 2021
What is Pre-Cessation?
Cessation and Pre-Cessation Definitions Terms Definition
Cessation Event Event whereby a reference rate is discontinued or unavailable permanently, triggering
Fallback. A typical LIBOR cessation event would occur if there were no longer sufficient panel banks contributing to calculation of LIBOR
Pre-Cessation Event An event which impacts the reference rate but does not prevent its publication. With respect to LIBOR, such an event could be where the FCA deems LIBOR unrepresentative per IOSCO principles (via EUBR legislation) thus preventing EU regulated market participants from entering into new contracts referencing LIBOR
ARRC17 recommended the industry to include Pre-Cessation as a Fallback Trigger event in the Fallback Provisions for Floating Rate Notes.
The forthcoming ISDA Definitions will include both pre-cessation fallbacks (based on a 'non-representativeness' determination) and permanent cessation fallbacks to apply to all new derivatives referencing LIBOR that incorporate the amended 2006 ISDA Definitions. For Legacy trades (i.e. those transacted prior to the effective date of the updated Definitions) these updated Definitions are expected to be incorporated via adherence to the ISDA Fallback Protocol.
What is 'Synthetic LIBOR'?
On 23rd June HM Treasury18 announced that it intends to bring forward legislation to amend the Benchmarks Regulation (BMR) to give the FCA enhanced powers. These could help manage and direct an orderly wind-down of critical benchmarks such as LIBOR. The proposed changes will create a possible way of reducing disruption by enabling continued publication of a LIBOR rate using different and more robust methodology and inputs.
The legislation would allow the FCA to direct the benchmark administrator to change the methodology, if doing so would better protect consumers and the integrity of the market than cessation of the rate. By acting via the administrator, the LIBOR rate (including the screen rates) would be preserved and remain in place.
We will refer to this continued publication of LIBOR under a different methodology as 'Synthetic LIBOR'.
What are the implications of 'Synthetic LIBOR' on Transition?
Regulators still expect the same focus and urgency from market participants to transition from LIBOR by primarily actively switching from LIBOR contracts into ARR contracts or failing that, to insert robust and workable fallback.
These new powers may allow the continued publication of LIBOR (including the screen rates) with a more robust methodology and inputs. However the exact format of Synthetic LIBOR is unknown and will be set with market input. It is expected to be based on some form of ARR and an adjustment spread.
The use of Synthetic LIBOR is also expected to be limited to what the FCA19 term as "Tough Legacy". These are contracts that have no or inappropriate/unviable alternatives and no realistic ability to be renegotiated or amended.
Also note that any continued publication of LIBOR is dependent on the proposed legislation being passed and that the FCA will exercise such powers, none of which is certain.
17 https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/FRN_Fallback_Language.pdf
18 https://www.fca.org.uk/markets/transition-libor/benchmarks-regulation-proposed-new-powers
19 https://www.fca.org.uk/news/statements/fca-statement-planned-amendments-benchmarks-regulation
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What has been the reaction to the HM Treasury announcement so far?
Prior to the HM Treasury announcement, the FCA outlined some scenarios to accelerate the transition from LIBOR to ARRs perhaps to address the counter-active effect that the possibility of LIBOR continuing may have on certain market participants.
These scenarios include the possibility of a pre-cessation or cessation announcement ahead of end 2021. This announcement would be in advance of the event or effective data but would have the effect of fixing the adjustment spread between LIBOR and the corresponding ARR which would apply at either pre-cessation or cessation date.
The GBP LIBOR market (at time of publication) is pricing such an announcement in early Q1 2021. It is not clear how such a cessation would fit with the enhanced powers proposed in the HM Treasury announcement.
Why is the Transition challenging for certain products?
Certain contracts which reference LIBOR (including bonds, structured products, securitized products, loans and a subset of existing contracts) may have characteristics that impede smooth transition such as product mechanics for material amendments, non-linearity, illiquidity or because they act as hedges to products with different fallback methods.
Non-Protocol Covered agreements and confirmations may need to be reviewed to determine an approach. Generally, this approach is likely to involve market participants being requested to sign documentation agreeing to the transition to the relevant replacement rate.
Why might these Forecasting Risk changes drive increased bilateral/ multilateral negotiation?
Due to the increased complexity introduced by the differences between asset class fallbacks and product amendment mechanics, the industry is expected to need to perform a significant review of contractual documentation before agreeing to change terms on their existing trades. Amendments to existing trades will be a challenging exercise if market participants have to amend a significant volume of trades across different products on a bilateral or multilateral basis.
What are the main drivers that may determine the impact on Forecasting Risk?
The level of impact on value and Forecasting Risk will be driven by but not limited to the following:
The specific legacy reference rate
Whether term rates become available
The specific fallback trigger provisions in existing contract(s)
Fallback rate to include an adjustment required to reflect the credit and term differences agreed by industry groups
The maturity of the contract(s)
The date when changes are expected to happen
The type of product as there are potentially differing industry solutions
There is no industry consensus on how the change in the value of contracts between parties will be handled.
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Summary and Practical Considerations
Clients should study existing contracts that reference LIBOR and consider future trading and risk management requirements and seek professional advice (if applicable) on the economic, legal, and operational implications. Clients may also consider their specific capital, accounting, and tax consequences of LIBOR transition.
Below are some of the practical considerations clients should take into consideration for this LIBOR transition.
Summary Practical Considerations include
Increased complexity may be introduced by the
differences between asset class fallbacks
You should perform a review of contractual
documentation before agreeing to change terms on
existing trades keeping in mind that current fallback
provisions may create, upon cessation, a fallback to a
rate inconsistent with the economics of the original
deal
Acknowledge that in any new fallback provisions
that specify an ARR to replace LIBOR, there may be
an adjustment (to address the term and credit
differences)
Updated ISDA Definitions published Q3 2020
Be aware of the changes required to incorporate the
updated ISDA Definitions for new contracts and the
ISDA IBOR Fallback Protocol for existing trades
Differences in fallback methodology across different
product types may impact hedge effectiveness across
transactions which you believe to be linked
Identify all transactions which you believe to be
linked and evaluate contractual fallbacks in place in
order to determine an approach to mitigate potential
differences in fallback methodology across these
transactions
Evaluation of current contractual fallback provisions
may lead to increased bilateral discussion
You may be requested to sign documentation
agreeing to the transition to the relevant
replacement rate or adopt the ISDA Benchmark
Supplement. However the latter is an alternative
path that does not provide certainty of economic
outcome
Stay up to date with the industry announcements
related to cessation or pre-cessation announcement
dates as these will fix fallback rates spreads. Also be
aware of how Synthetic LIBOR methodology
develops as some 'Tough Legacy' contracts may end
up referencing this rate
Categorize your in-scope population of trades in
relation to possible transition activities. Note any
dependencies you require such as market readiness
or internal system/operational development.
If you have any further questions, in the first instance please contact your sales representative. Alternatively,
please get in touch via [email protected].
18
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5. From 2017 to Date: Regulatory and Market Milestones
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6. Upcoming Regulatory and Market Milestones
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7. Appendix
From 2017 to Date: Regulatory and Market Milestones
Date
Industry/
Regulatory update
Impacted
Rate Impact
April 2017 SONIA selected as preferred GBP
ARR
SONIA
June 2017 ARRC selects SOFR as its
recommended alternative to USD
LIBOR
SOFR
July 2017 A. Bailey (FCA) speech on panel
banks not being compelled to
submit to LIBOR post 2021
LIBOR
October
2017
The National Working Group on
Swiss Franc Reference Rates
recommends SARON as the
alternative to CHF LIBOR
SARON
April 2018 SONIA (reformed) begins
publication
SONIA Underpinned by £40-50 billion daily transactions. The Bank of
England assumes end to end administration; coverage
broadens to include bilaterally negotiated overnight
unsecured transactions and the averaging methodology
changes to reflect a trimmed mean.
April 2018 SOFR published SOFR The Federal Reserve Bank of New York begins publishing
SOFR, which is underpinned by the U.S. Treasury overnight
repurchase (repo) market, for which the pool of eligible
transactions is ~$750 billion per day.
May 2018 CME launches SOFR futures SOFR CME Group launches 1-month and 3-month SOFR futures
contracts.
June 2018 €STR methodology announced €STR
June 2018 First-ever SONIA-based floating
rate note issued
SONIA
July 2018 First-ever SOFR-based floating rate
note, issued by Fannie Mae
SOFR Issuance Size USD 6 billion.
September
2018
€STR recommended as alternative
EUR ARR & replacement for
EONIA
EONIA,
€STR
Reformed EURIBOR is expected to continue alongside €STR as
a multiple rate approach. The European Commission has
expressed confidence in EURIBOR for the medium term. As
with other LIBORs, EUR LIBOR is expected to cease.
March 2019 ECB WG recommends transition
from EONIA to €STR
EONIA,
€STR
ECB WG advises market participants to gradually replace
EONIA with the €STR as a reference rate for all products and
contracts and make all the necessary adjustments for using
the €STR as their standard benchmark.
June 2019 1st FRN Reference Rate switch
from GBP LIBOR to SONIA
GBP
LIBOR,
SONIA
Associated British Ports becomes first borrow to secure
bondholder approval to switch from LIBOR to SONIA.
July 2019 EURIBOR authorized under
Benchmarks Regulation
Euribor The Financial Service and Markets Authority (FSMA) of
Belgium authorize EMMI as administrator of EURIBOR and
hybrid EURIBOR is confirmed as EU benchmark regulation
(BMR) compliant.
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Date
Industry/
Regulatory update
Impacted
Rate Impact
Aug 2019 Identifies SORA as the ARR to
replace SOR
SOR /
SORA
ABS-SFEMC issued consultation on 30th August 2019. As
SOR is dependent on USD LIBOR, the likely discontinuation of
LIBOR post 2021 impacts future sustainability of SOR.
2nd October
2019
EONIA becomes €STR + spread
(8.5bps)
€STR EONIA still available but published as €STR + 8.5bps
The European Central Bank started publishing €STR from 2
October 2019, reflecting the trading activity of 1 October
2019.
4Q 2019 International Accounting
Standards Board (IASB) Guidance
All ARR
January
2020
Letter to Senior Managers – Next
steps on LIBOR transition
All LIBOR
January
2020
UK RFR WG 2020 Top Level
Priorities
GBP
LIBOR /
SONIA
24th January
2020
ARRC Releases Recommendations
for Interdealer Cross-Currency
Swap Market Conventions
All ARR
March 6th
2020
ARRC Releases a Proposal for New
York State Legislation for U.S.
Dollar LIBOR Contracts
USD
LIBOR /
SOFR
March 2020 Path to
discontinuation of new
GBP LIBOR lending by end Q3
2020
GBP
LIBOR /
SONIA
March 2020 Statement on bond market
conventions
SONIA
25th March
2020
Statement on the impact of
coronavirus on firms’ LIBOR
transition plans
ALL
LIBOR /
All ARR
8th April
2020
ARRC Announces
Recommendation of a Spread
Adjustment Methodology for
Cash Products
USD
LIBOR
9th April
2020
FINMA send second "Dear CEO"
Letter
CHF
LIBOR /
SARON
Outlines steps that FINMA expect banks and securities firms
to undertake by end of 2020.
7th May
2020
Draft template for a SARON /
SOFR Cross Currency Basis Swap
confirmation
SARON /
SOFR
May 2020 Paper on the identification of
Tough Legacy issues
GBP
LIBOR
26th May
2020
Statement regarding Calculation
and Publication of Prototype Rates
for Term Reference Rates
JPY LIBOR QUICK Corp. selected as a calculating and publishing entity
of prototype rates (which are not presumed to be used in
actual transactions) for Term Reference Rates (term structures
based on Japanese yen [JPY] overnight index swap).
27th May
2020
ARRC Announces Best Practices
for Completing Transition From
LIBOR
USD
LIBOR /
SOFR
1st June
2020
Dear CEOs letter to Major
Financial Institutions regarding
LIBOR Transition (BoJ/FSA)
JPY LIBOR
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Date
Industry/
Regulatory update
Impacted
Rate Impact
1Q 2020 Decided on Adjusted SOR as
contractual fallback for derivatives
SORA
1Q 2020 Published ISDA definition for
compounded SORA
SORA
1Q 2020 Established market conventions
for SORA OIS, CCS, SOR-SORA
Basis-Swaps
SORA
16th June
2020
Recommendation on swaptions
affected by the central clearing
counterparties’ discounting
transition from EONIA to the €STR
EONIA /
€STR
23rd June
2020
HM Treasury 'Tough Legacy'
Guidance
All LIBOR
30th June
2020
ARRC Announces Further Details
Regarding Its Recommendation of
Spread Adjustments for Cash
Products
USD
LIBOR /
SOFR
30th June
2020
ARRC Releases Updated
Recommended Hardwired Fallback
Language for Syndicated Loans
USD
LIBOR /
SOFR
10th July
2020
Letter to Authorized Institutions
(AIs) from HKMA
All LIBOR
/ All ARRs
Key Milestones that AIs should endeavor to achieve in the
transition to ARRs
July 2020 The UK RFR Working Group’s
latest priorities and roadmap for
2020-2021
GBP
LIBOR /
SONIA
July 2020 Q&A for UK RFR Working Group’s
end-Q3 2020 loans milestone
GBP
LIBOR /
SONIA
22nd July
2020
ISDA letter on IBOR Fallback
protocol
All LIBOR
/ All ARR
ISDA expects to facilitate a process whereby regulated entities
and other key market participants can adhere to the IBOR
Fallback Protocol ‘in escrow’ prior to the launch date.
22nd July
2020
ARRC Releases Conventions
Related to Using SOFR in Arrears
for Syndicated Loans
SOFR
27th July
2020
LCH, CME & EUREX switch from
EONIA to €STR for PAI and EUR
discounting
EONIA,
€STR
CSA renegotiation to move from EONIA to €STR for
discounting on EUR to align to cleared contracts.
3rd August
2020
SONIA compounded index
published
SONIA
19th August
2020
ARRC Updates Best Practices to
Encourage Adherence to ISDA
Protocol During Escrow Period
All LIBOR
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Upcoming Regulatory and Market Milestones
Date
Industry/
Regulatory update
Impacted
Rate Impact
3Q 2020 Updated ISDA Definitions and
IBOR Fallback Protocol to
address existing contracts
published
All ARR/LIBOR
3Q 2020 Loan market conventions
proposed (BoE)
GBP LIBOR
3Q 2020 No new USD LIBOR residential
mortgage maturing after end
of 2021 (ARRC)
USD LIBOR
3Q 2020 Launch SORA-based bilateral /
syndicated loans
SORA
3Q 2020 Pilot SORA retail loans SORA
3Q 2020 Publish guidance on product
conventions
SORA
3Q 2020 Publish customer guide on
using compounded-in-arrears,
term rates, fixed rates; Pilot
retail loans
SORA
3Q/4Q 2020 Statement on credit spread
methodology for cash &
successor rates published
(BoE)
GBP LIBOR /
SONIA
4Q 2020 Widespread sign up to the
ISDA protocol achieved ahead
of effective date (FCA/ARRC)
All ARR/LIBOR
4Q 2020 Operationally ready to support
the development & market
making of nonlinear SONIA
derivatives (FCA)
SONIA
4Q 2020 Progress active conversion of
cash products where viable to
reduce legacy volume (BoE)
GBP LIBOR
4Q 2020 Updated ISDA Definitions
effective date + 3-4 months
from publication
All ARR/LIBOR Adherence to the Protocol across the client base will require
client contact and agreement.
19th
October
2020
LCH, CME & EUREX Group
switch from EFFR to SOFR for
PAI and USD discounting
SOFR CSA renegotiation to move from EFFR to SOFR for
discounting on USD to align to cleared contracts.
4Q 2020 Transition to TONA for
standard inter-dealer
derivative trades
TONA
4Q 2020 Transition to TONA for
standard inter-dealer
derivative trades
JPY LIBOR
4Q 2020 No new USD LIBOR FRNs
maturing after end of 2021
(ARRC)
USD LIBOR
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Date
Industry/
Regulatory update
Impacted
Rate Impact
4Q 2020 Reduction of CHF LIBOR-
based cash products without
fallback or a written
agreement for defining the
alternative reference interest
rate after 2021 (FINMA)
CHF LIBOR
4Q 2020 Introduction of robust fallback
clause for new CHF LIBOR-
based cash products expiring
after 2021
CHF LIBOR
4Q 2020 Making markets in SOFR-
linked interest rate volatility
products
SOFR
4Q 2020 Amend inter-dealer CSAs to
use SOFR (ARRC)
SOFR
1Q 2021 SONIA term rate available SONIA
1Q 2021 Cease new issuance of
Sterling LIBOR referencing
products (Bonds &
Securitisations) maturing after
2021
GBP LIBOR
1Q 2021 Cease initiation of new
Sterling LIBOR linked linear
derivatives expiring after 2021
(except for risk management
of existing positions) (FCA)
GBP LIBOR
1Q 2021 Accelerate active conversion
where to reduce legacy
volume (FCA)
GBP LIBOR
1Q 2021 Complete assessment of all
post 2021 cash contracts to
identify those that can be
actively converted (FCA)
GBP LIBOR
1Q 2021 Dealers change market
convention quoting from USD
LIBOR to SOFR (ARRC)
USD LIBOR /
SOFR
2Q 2021 SGD – Term-SORA expected SORA
2Q 2021 Guidance on cessation date
for new SOR originations and
transition mechanisms
SOR/SORA
2Q 2021 No new USD LIBOR business
loans maturing after end of
2021
USD LIBOR
2Q 2021 No new USD LIBOR
securitization maturing after
end of 2021 (except CLOs)
USD LIBOR
2Q 2021 No new derivatives trades
maturing end 2021 (ARRC)
USD LIBOR
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Date
Industry/
Regulatory update
Impacted
Rate Impact
Q2/Q3 2021 Cease trading of LIBOR linked
non-linear derivatives, and
cross currency derivatives with
a sterling leg, expiring after
2021 (except for risk
management of existing
positions) (FCA)
GBP LIBOR
Q2/Q3 2021 Assess and actively convert
where viable (e.g. auction /
compression mechanisms for
derivatives). (FCA)
GBP LIBOR
Q2/Q3 2021 Complete active conversion of
cash products. Where active
conversion is not possible for
loans, ensure robust fallbacks
are adopted (FCA)
GBP LIBOR
3Q 2021 No new USD LIBOR CLOs
(corporate or CRE) (ARRC)
USD LIBOR
4Q 2021 SOFR forward looking term
rate expected
SOFR
4Q 2021 Final recommendations on
EURIBOR fallbacks and related
solutions to amend EURIBOR
legacy contracts
EURIBOR
Dec 2021 Assumed cease of LIBOR
publication
All
Dec 2021 EONIA ceases to exist EONIA, €STR
Note: Accurate as of time of publication, dates may be subject to change pending further regulatory & industry feedback.
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Other IBORs Benchmark Rates
The other IBOR benchmark rates are detailed in the below table. .
Jurisdiction Reference Rate Administrator Commentary
Euro Area EURIBOR EMMI The most widely used benchmark of the other IBORs; the European Commission has expressed confidence in EURIBOR for the medium term. A new hybrid methodology is in the process of being implemented.
The ECB RFR WG proposed roadmap20 (published in late 2019) suggests that 2020 work focus are on:
i) EONIA transition to ESTR, particularly on building liquidity for ESTR and the CCP discounting switch that occurred on Monday 27 July, and
ii) Development of ESTR-based fallbacks for EURIBOR, however the final recommendation has been deferred to Q1 2021 due to COVID 19 impact per the May ECB RFR WG minute.
A list of key milestones and publications can be found from the ECB RFR WG website21
Japan TIBOR JBA BoJ consultation on JPY Interest Rate Benchmarks: Following results of 1st Consultation (Integrating Japanese Yen TIBOR and Euroyen TIBOR), the most likely option as at 30 May 2019, is retaining Japanese Yen TIBOR and discontinuing Euroyen TIBOR ('retaining Japanese Yen TIBOR').
Australia BBSW ASX RBA22 statement on BBSW: At an ISDA Forum in May 2019,
RBA said BBSW is a robust benchmark that can continue. Notice advising ASX Market participants that ASX Benchmarks will deliver a number of external facing enhancements to BBSW and AONIA, effective 28th October 2019. No cessation notices.
China SHIBOR NIFC Shanghai No significant notices on cessation or change to the benchmark noted (further research required).
Hong Kong HIBOR TMA TMA consultation HIBOR ARR: AGM June 2019 - TMA Confirmed HKD Overnight Index Average (HONIA) as the alternative reference rate for HIBOR and completed a consultation on a few technical refinements to HONIA early this year.
Singapore SIBOR ABS SIBOR discontinuation announcement is expected by end Q4
2020. The ABS is consulting on the discontinuation timelines and replacement approach.
Note: This information has been sourced from administrator websites and is accurate as of 1st July 2020.
20 https://www.ecb.europa.eu/paym/initiatives/interest_rate_benchmarks/WG_euro_risk-free_rates/shared/pdf/20191204/2019_12_04_WG_on_euro_RFR_meeting_Item_2_Planning_for_the_WG_H1_2020.pdf
21 https://www.ecb.europa.eu/paym/initiatives/interest_rate_benchmarks/WG_euro_risk-free_rates/html/milestones.en.html
22 https://www.rba.gov.au/speeches/2019/sp-dg-2019-04-11.html
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Overnight Index Swap Industry Definitions Terms Definition
Compounding Daily compounding of the ARR (current standard in the Overnight Index Swap market)
Averaging Daily averaging of the ARR
Lockout The rate is taken from a set day for the remainder of the period E.g. a 4 day lockout period takes the rate on payment day minus 4 and uses this same rate
for the remainder of the term The rate used to calculate a rate for each day in an interest period is based on the rate that
represents transactions from a prior day e.g. with a 2 day shift / lookback the observation period starts and ends 2 days prior to
interest period start and end dates
The rate is taken from a set day for the remainder of the period e.g. a 4 day lockout period takes the rate on payment day minus 4 and uses this same rate
for the remainder of the term
Backward Shift / Lookback
The rate used to calculate a rate for each day in an interest period is based on the rate that
represents transactions from a prior day E.g. with a 2 day backward shift / lookback the observation period starts and ends 2 days
prior to interest period start and end dates
ARR detailed information Jurisdiction Target ARR Publication Transaction Data Sources Available as of
US Secured Overnight Financing Rate (SOFR)
Around 8am EST next business day
Tri-Party, General Collateral Financing, Bilateral Treasury repos
3 April 2018
UK Sterling Overnight Index Average (SONIA)
At 9am GMT next business day
Unsecured overnight bilateral transactions
23 April 2018 (reformed)
Euro Area Euro Short Term Rate (€STR)
At 9am CET next business day
Volume weighted average based exclusively on the eligible data from the unsecured market segment of the Money Market Statistical Reporting to the ECB
2 October 2019
Switzerland Swiss Average Rate Overnight (SARON)
At 6pm CET same business day
Interbank repo 25 August 2009
Japan Tokyo Overnight Average Rate (TONA)
At 10am JST next business day
Money Market brokers 1 November 1997
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8. Bibliography
1 ICE Benchmark Administration Methodology, available athttps://www.theice.com/iba/libor#methodology
2 Impact of the coronavirus on firms’ LIBOR transition plans available at
https://www.fca.org.uk/news/statements/impact-coronavirus-firms-libor-transition-plans
3 IOSCO Benchmark Principles, available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD415.pdf
4 Andrew Bailey, The future of LIBOR (July 7, 2017), available at https://www.fca.org.uk/news/speeches/the-
future-of-libor
5 Definition of Price Aligned Interest available at https://www.theotcspace.com/content/price-alignment-
interest-pai
6 LCH SOFR Discounting Letter, available at
https://www.cftc.gov/media/2421/MRAC_LCHSOFRDiscountingLetter090919/download
7 SOFR Discounting and Price Alignment Transition—Proposal for Cleared Swaps, available at
https://www.cmegroup.com/education/articles-and-reports/sofr-price-alignment-and-discounting-
proposal.html
8 "Margin requirements for non-centrally cleared derivatives" regulations available at
https://www.bis.org/bcbs/publ/d475.htm
9 Recommendation by the working group on euro risk free rates – On swaptions affected by the central
clearing counterparties' discounting transition from EONIA for the €STR, available at
https://www.ecb.europa.eu/pub/pdf/other/ecb.recommendation_swaptions_impacted_by_discounting_swi
tch_to_EuroSTR~a64f042ed9.en.pdf
10 ARRC Recommendations for Swaptions Impacted by the CCP Discounting Transition to SOFR available at
https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-swaptions-
recommendations.pdf
11 Andrew Bailey, LIBOR Transition Briefing (July 15. 2019), available at
https://www.fca.org.uk/news/speeches/libor-preparing-end
12 ISDA Benchmark Supplement, available at https://www.isda.org/book/isda-benchmarks-supplement/
13 "CME and LCH have each also communicated to ISDA and regulators that they may elect to consider pre-
cessation triggers for fallbacks if LIBOR was found to be non-representative, even if the 2006 ISDA
Definitions do not include them", available at https://www.isda.org/a/md6ME/FINAL-Pre-cessation-issues-
Consultation.pdf
14 CFTC's Market Risk Advisory Committee approved plain English disclosures for new derivatives referencing
the London Interbank Offered Rate (LIBOR) and other IBORS, available at
https://www.cftc.gov/media/2491/MRAC_IBORDisclosures090919/download.
15 ISDA adoption of risk free rates major developments available at https://www.isda.org/a/WhXTE/Adoption-
of-Risk-Free-Rates-Major-Developments-in-2020.pdf
16 ARRC Recommended Best Practices for Completing the Transition from LIBOR available at
https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-Best-Practices.pdf
17 ARRC recommendations on Pre-Cessation in Fallback provisions for FRNs, available at
https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/FRN_Fallback_Language.pdf
18 Benchmarks Regulation – proposed new powers – available at https://www.fca.org.uk/markets/transition-
libor/benchmarks-regulation-proposed-new-powers
19 FCA statement on planned amendments to the Benchmarks Regulation available at
https://www.fca.org.uk/news/statements/fca-statement-planned-amendments-benchmarks-regulation
20 The ECB RFR WG proposed roadmap, available at
https://www.ecb.europa.eu/paym/initiatives/interest_rate_benchmarks/WG_euro_risk-
free_rates/shared/pdf/20191204/2019_12_04_WG_on_euro_RFR_meeting_Item_2_Planning_for_the_WG
_H1_2020.pdf
21 The ECB RFR WG list of key milestones and publications, available at
https://www.ecb.europa.eu/paym/initiatives/interest_rate_benchmarks/WG_euro_risk-
free_rates/html/milestones.en.html
22 RBA speech to Bloomberg - Progress on Benchmark Reform – 11/04/2019, available at
https://www.rba.gov.au/speeches/2019/sp-dg-2019-04-11.html
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29
9. Glossary
Term Definition
€STR Euro Short Term Rate
ARR Alternative Reference Rate
ARRC Alternative Reference Rate Committee
CCP Central Clearing Counterparty
CFTC Commodities, Futures Trading Commission
CME Chicago Mercantile Exchange
CSA Credit Support Annex
EFFR Effective Fed Funds Rate
EMMI European Money Markets Institute
FBF Federation Bancaire Francaise
FCA Financial Conduct Authority
FRBNY Federal Reserve Bank of New York
IBA ICE Benchmark Administration
ICE InterContinental Exchange
IOSCO International Organization of Securities Commissions
ISDA International Swaps and Derivatives Association
LCH London Clearing House
LIBOR London Interbank Offered Rate
OTC Over-the-Counter
PAI Price Aligned Interest
SARON Swiss Average Rate Overnight
SMA Swiss Master Agreement
SOFR Secured Overnight Funding Rate
SONIA Sterling Overnight Index Average
TONA Tokyo Overnight Average Rate
SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.2 - PA BIB.docx
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