The LIBOR Transition - FAQs, Updates and More

The London Interbank Offered Rate (LIBOR) is the most commonly used benchmark for short-term interest rates and often is referenced globally in documentation for derivatives, bonds, business loans and consumer financial products. The setting of LIBOR is made daily on London business days by submissions of the average rates at which LIBOR panel banks believe they can obtain wholesale unsecured funding. It is estimated that $200 trillion of financial instruments (loans, bonds, derivatives and consumer financial products) are tied to LIBOR and that matters to everyone – small businesses, corporations, banks, broker dealers, consumers and investors.

In March 2021, LIBOR’s administrator and regulator have confirmed the endgame for LIBOR. The ICE Benchmark Administration (IBA) ceased publication of the one-week and two-month USD LIBOR tenors immediately after December 31, 2021, and the remaining tenors (i.e., Overnight/Spot Next, 1-month, 3-month, 6-month and 12-month) will cease on a representative basis immediately after June 30, 2023. The period between end-2021 and mid-2023 is primarily intended to allow legacy contracts to mature.

In November 2020, U.S. federal banking regulators encouraged banks to cease entering into new contracts that use LIBOR no later than December 31, 2021. The Alternative Reference Rates Committee (ARRC) also recommended no new LIBOR-based business loan contracts to be originated after June 30, 2021. Transition to alternative benchmark interest rates is well underway, but much work lies ahead to implement a successful reference rate change.

As of December 31, 2021, the 1-week and 2-month LIBOR settings were no longer being published.

In 2014, the U.S. Federal Reserve and the New York Federal Reserve Bank (NY Fed) established the ARRC to lead the transition away from LIBOR. It recommended the Secured Overnight Financing Rate (SOFR) as the replacement for LIBOR and encouraged the development of a SOFR futures market.

For the most recent information about the ARRC, please visit here.  

In June 2017, the ARRC identified SOFR as the recommended alternative reference rate for LIBOR. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities (each a repurchase or repo transaction). While LIBOR is not fully transaction based, SOFR is based on an overnight repo market with ~ $1 trillion of transactions per day. The NY Fed is the administrator and producer of SOFR. Publication of SOFR began in April 2018. Trading and clearing of SOFR based futures and SOFR-based swaps began in 2018.

SOFR is calculated as a volume-weighted median of transaction level tri-party repo transaction data, General Collateral Finance repo transaction data and data on bilateral U.S. Treasury repos cleared through Fixed Income Clearing Corporation's delivery-versus-payment service provided by DTCC Solutions LLC. SOFR is published each business day on the NY Fed’s website, while Term SOFR is published on the CME Group website.

In April 2021, the ARRC published its progress report on the transition from LIBOR, outlining key reference rate reform efforts, progress to date, and areas requiring further work. The “Progress Report: The Transition from U.S. Dollar Libor” also included the ARRC’s 2021 Objectives and Priorities to support a smooth and efficient transition from LIBOR.

In September 2020, the ARRC updated its recommended Best Practices for Completing Transition From LIBOR, originally released in May 2020. The ARRC’s Best Practices were intended to clarify the timelines and interim milestones for floating rate notes, business loans, consumer loans, securitizations and derivatives that the ARRC believed were appropriate for transitioning away from LIBOR in order to minimize market disruption and support a smooth transition to SOFR. 

ARRC’s Recommended Best Practices for Completing the Transition from LIBOR can be found here.  

As noted by the ARRC, LIBOR and SOFR have different characteristics, and where a LIBOR contract is falling back to SOFR, a spread adjustment will be added to make the rate more comparable to LIBOR. Therefore, the ARRC-endorsed fallback language provides for static spread adjustments that were fixed on March 5, 2021.

The fixed spread adjustments for LIBOR fallbacks are based on a 5-year historical median of the spread between the relevant LIBOR tenor and SOFR. The ARRC’s recommended spread adjustments for non-consumer cash products are the same as ISDA’s spread adjustments for LIBOR.

However, even with a credit spread adjustment, no replacement benchmark is likely to be neutral to all parties; some will benefit, and others will not.

A transaction that references LIBOR or another interbank offered rate (IBOR) and matures or expires after the time LIBOR is expected to be unavailable will possibly need to be amended.

The ARRC recommended that no new LIBOR business loans maturing after 2021 be originated after June 30, 2021 and U.S. federal banking regulators encouraged banks to cease entering into new contracts that use LIBOR no later than December 31, 2021.

The ARRC, as well as trade associations and industry working groups, have developed contractual language to be included in contracts known as “fallback provisions” that specify what will happen when the benchmark rate it now references (such as LIBOR) is discontinued, non-representative or unavailable. Such provisions reflect industry standard terms and will also be incorporated into new contracts, unless parties explicitly agree otherwise.

It is a provision in the agreement for a loan, bond, derivative, or another financial instrument specifying a new interest rate benchmark or negotiation process to be followed by the transaction’s parties to determine a replacement rate if the interest rate used in that contract becomes unavailable. The ARRC has recommended fallback provisions for new LIBOR-dependent syndicated and bilateral loans, floating rate notes, securitizations, and residential adjustable rate mortgages to help transition away from LIBOR when it becomes unavailable. Those recommended provisions can be found here. 

Yes, Term SOFR is now available in the following tenors: 1,3,6,12-month.  On July 29, 2021, the ARRC formally recommended CME Group’s forward-looking SOFR Term Rates. The announcement was a milestone in the industry’s transition away from LIBOR, marking the completion of the Paced Transition Plan that the ARRC outlined in 2017.

The ARRC periodically publishes a newsletter with key news updates relating to the LIBOR transition and such newsletters can be found here. 

ISDA published an IBOR Fallbacks Supplement to its 2006 Definitions for derivatives contracts that became effective on January 25, 2021. New transactions that incorporate the 2006 ISDA Definitions or the 2021 ISDA Interest Rate Derivatives Definitions and reference LIBOR will incorporate fallbacks upon specified cessation events for such LIBORs to one or more “risk free” reference rates (each a fallback rate) together with a published spread adjustment.

ISDA continues to publish additional materials for use by market participants to facilitate the LIBOR transition, as well as for additional benchmarks, in line with global developments.  ISDA published the 2020 IBOR Fallbacks Protocol (the Protocol) on October 23, 2020 to enable market participants to amend their legacy uncleared derivatives and certain other contracts with other adhering parties to include the new fallback rates. The Protocol generally covers relevant IBOR transactions governed by ISDA master agreements, ISDA credit support documentation, subject confirmations, certain local law swaps and derivatives master agreements, repurchase agreements and securities lending agreements. ISDA has also published templates that parties may employ to bilaterally incorporate Protocol terms or to otherwise amend, include or exclude certain master agreements or transactions from the scope of coverage of the Protocol.

ISDA has also published a 2020 IBOR Fallbacks Protocol FAQ. The FAQ and additional information are available on the ISDA website.

Yes. Union Bank established a LIBOR Transition Office in 2019 to manage the transition for our customers and provide oversight for the company. In an effort to mitigate the risks associated with a transition away from LIBOR, Union Bank has undertaken initiatives to: (i) develop more robust fallback language and disclosures related to the LIBOR transition, (ii) develop a plan to seek to amend certain legacy contracts to reference such fallback language or alternative benchmark rates, (iii) launch and enhance systems to support new products linked to alternative benchmark rates, (iv) develop and evaluate internal guidance, policies and procedures focused on the transition away from LIBOR to other benchmark rates and (v) prepare and disseminate internal and external communications regarding the LIBOR transition.

Contracts that mature prior to 6/30/23 will not be amended or changed, but rather be allowed to reach their natural end date. Any new contracts generated after 12/31/21 will be originated using a non-LIBOR benchmark rate. If a client has a contract that matures post 6/30/23, your Relationship Manager will reach out to you to determine the appropriate course of action for both a loan and a derivative. 

(1) Learn more about LIBOR cessation, transition and replacement rate developments; (2) analyze your LIBOR exposure with a focus on financial instruments maturing beyond June 30, 2023 and what effect the discontinuation of LIBOR might have on that exposure; (3) engage with your counterparties, vendors and financial institutions to begin the process of identifying and amending LIBOR-dependent contracts; and (4) consider the impact that a change to a replacement rate may have on accounting, tax, IT, systems and operations.