IBOR Transition Update (Mar 21)

The Future of LIBOR

Initial concern developed into formal announcements in 2017 that the publication and use of LIBOR must come to an end. The date initially mooted for this was the end of 2021, which must have seemed a very long way away in 2017. LIBOR was to be supplanted by a series of replacement “Risk Free Rates'' or RFRs, which would provide the markets the tools they needed to continue to function in the absence of LIBOR, but would not have the inherent vulnerabilities of LIBOR or other IBOR rates.

Whilst LIBOR reform work has been underway at speed since the financial crisis in 2007/8, it was perhaps only after the announcement of LIBOR’s demise that markets and the official sector began to grasp what a truly Herculean effort this would be. To their credit, international authorities did give this work their attention, and ensured that the reform work is backed by the most senior bodies. It is being coordinated by the G20 and overarching direction is given by the Financial Stability Board, or FSB. Beneath these supranational bodies, implementation is driven by individual regulators and central banks using a mixture of law, regulation and output from market committees.

Who are the players in LIBOR transition?

• Market participants
• The official sector
• Trade bodies

Who will LIBOR impact?

Every financial institution, including banks, asset managers, insurers, and others, will be affected by the LIBOR transition. It will have an impact on corporations and public finance issuers whose lending and borrowing are often connected to LIBOR. Individuals whose mortgages are often connected to LIBOR are also affected, particularly in the US.

Why has the official sector had to change the position?

This position has had to change, for a number of reasons:

• Firstly, the markets were extremely reluctant to move from LIBOR, a rate they understood and was baked-in to the system because everyone used it. The new RFRs are largely unproven, and moving to them represents huge risk for little reward, at least as the market perceives it.
• Secondly, the sheer scale and quantum of this risk has persuaded the official sector that they will need to act, partly to push change, but mainly to reduce risk by offering secure legal frameworks for participants to stay within.
• Thirdly, initial deadlines had all been aspirational, or hypothetical, and certainly not legally binding, and as such, effectively disregarded by large parts of the financial markets.

What is the role of trade bodies in the LIBOR transition?

Trade bodies can offer guidance to their member firms which enjoy endorsement by the official sector to at least some degree. One in particular stands out – ISDA, the International Swaps and Derivatives Association, which owns and designs a large number of standardised contracts that members can use to make a wide range of derivatives contracts legally frictionless and far less risky.

What happened on March 5th 2021?

On Friday, March 5th there were a series of tightly coordinated announcements made by the FCA, ICE Benchmark Administration and the Federal Reserve. These represent the most seismic event in LIBOR transition since then FCA Chief Executive and now Bank of England Governor Andrew Bailey announced in 2017 that LIBOR would cease at the end of 2021.

There are currently 35 LIBOR rates still published, these are: Overnight, 1 week, 1 month, 2 month, 3 month, 6 month and 12 month in each of the US Dollar, Pound Sterling, Euro, Swiss Franc and Japanese Yen. Most of these, including all Euro and Swiss Franc rates will permanently cease publication at the end of 2021. Overnight, 1 week, 2 month and 12 month rates in Sterling and Yen and overnight and 2 month rates in US Dollars will also cease permanently at the end of 2021. So far, so clear. That is 24 rates accounted for. It will simply not be possible to continue using these rates for existing business or to write new business against them after the end of 2021.

In short, regulators in the UK and US have taken every step short of absolute regulatory prohibition in regards to writing new business against the LIBOR rates that will continue beyond 2021.

What do recent announcements mean?

These announcements mean that lenders and administrative agents should notify all parties that an announcement on LIBOR cessation has occurred. These announcements have also triggered so-called ISDA fallback protocols. These fallback protocols allow for rates to be calculated as a spread to the applicable Risk Free Rate, and these have all been published by ISDA’s nominated calculator, Bloomberg. These spreads are now fixed and allow firms to begin to plan, model and hedge.

There will be a number of consultations issued in the UK and US that will address the uncertainties and finally the stance amongst the official sector to alternatives to LIBOR will continue to soften.