Industry Update: USD London Interbank Offer Rate (LIBOR) Timeline and Next Steps
MUFG Union Bank would like to bring you up to date on certain new information regarding the London Interbank Offer Rate for U.S. dollars (LIBOR), including some important dates and next steps in the transition. Click here for more information.
What you need to know
This is a brief update of impending changes to the London Interbank Offered Rate (LIBOR). LIBOR has been a long-standing index for financial transactions and is currently the most commonly used variable interest rate index for short-term interest rates, business loans, variable-rate loans, financial derivative contracts, and other commercial lending products.
Things to keep in mind
LIBOR transition timeline
Frequently asked questions
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 in 5 currencies (USD, GBP, EUR, JPY and CHF) and 7 maturities (from overnight to 12 months). It is estimated that $200 trillion of financial instruments (loans, bonds, derivatives and consumer financial products) are tied to USD LIBOR and that matters to everyone – small businesses, corporations, banks, broker dealers, consumers and investors.
In 2017, LIBOR’s regulator decided that it will not compel LIBOR panel banks to make LIBOR submissions after 2021. It is very likely that LIBOR may no longer be available after the end of 2021 and therefore LIBOR is expected to be phased out of use by financial market participants by the end of 2021. Transition to alternative benchmark interest rates is well underway, but much work lies ahead in order to implement a successful reference rate change by the end of 2021.
In 2014, the U.S. Federal Reserve and the New York Federal Reserve Bank (NY Fed) established the Alternative Reference Rates Committee (ARRC) to lead the transition away from LIBOR. The ARRC continues to lead the transition in the U.S. from LIBOR. It recommended the Secured Overnight Financing Rate (SOFR) as the replacement for USD LIBOR and encouraged the development of a SOFR futures market.
In June 2017, the ARRC identified SOFR as the recommended alternative reference rate for USD 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 began in May 2018 and SOFR-based swaps in July 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.
In April 2020, the ARRC unveiled a set of key objectives for 2020. Those goals and anticipated milestones were built on the ARRC’s then existing work and underscored the important progress that the ARRC had made during the preceding year in achieving market readiness and supporting the voluntary adoption of SOFR. It can be found at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC_Press_Release_2020_Objectives.pdf.
Thereafter, the ARRC released in May 2020 its recommended Best Practices for Completing Transition From LIBOR, which subsequently were updated in Sept. 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.
For key target dates by product and more information regarding the ARRC’s, see https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-Best-Practices.pdf
As noted by the ARRC, LIBOR and SOFR are different rates and the transition from LIBOR to SOFR will require a spread adjustment to make the rate levels more comparable. Therefore, the ARRC-endorsed fallback language provides for a static spread adjustment that would be fixed at a specified time at or before LIBOR’s cessation and make the spread-adjusted rate comparable to LIBOR by minimizing the expected change in value arising from the move to a replacement benchmark based on SOFR.
Based on the feedback from two market consultations conducted by the ARRC, the ARRC recommended a spread adjustment methodology based on the historical median difference between LIBOR and SOFR over a five-year lookback period prior to the occurrence of the LIBOR cessation trigger event. For consumer products, the ARRC additionally recommended a one year transition period to the five-year median spread adjustment methodology.
The ARRC additionally advised that its recommended spread adjustment values for cash products will align with the spread adjustment values that the International Swaps and Derivatives Association (ISDA) plans to implement in its standard definitions for derivatives.
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. Additional information from the ARRC regarding spread adjustments can be found here https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC_Recommendation_Spread_Adjustments_Cash_Products_Press_Release.pdf.
The ARRC recommended a spread adjustment methodology based on a historical median over a five-year lookback period calculating the difference between LIBOR and SOFR. The ARRC’s methodology matches the methodology recommended by ISDA for derivatives.
According to the ARRC, this would make the spread-adjusted version of SOFR comparable to LIBOR and consistent with ISDA’s fallbacks for the derivatives markets. The ARRC previously advised that its spread adjustment would be static, and it would be fixed at a specified time at or before LIBOR’s cessation.
For consumer products, the ARRC is recommending a one-year transition period to this five-year median spread adjustment methodology.
A transaction that references LIBOR or another interbank offered rate (IBOR) and matures or expires after the time LIBOR is expected to be unavailable likely will need to be amended. This will be an expansive task given the large number of contracts referencing LIBOR. MUFG is working within its internal IBOR Transition Program to identify those contracts and prepare for their amendment.
Many continue to reference LIBOR. 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 no longer available. 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 USD 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 at https://www.newyorkfed.org/arrc/fallbacks-contract-language.
SOFR is solely based on overnight transactions and does not yet have a forward term rate structure. The ARRC’s Paced Transition Plan calls for the creation of a forward-looking term SOFR structure based on SOFR-linked derivative markets before the end of 2021. Without a forward term SOFR structure, the alternative SOFR interest calculation methods now prevalent in the market are a compounded or simple average of historical overnight SOFR set in arrears. One limitation in using these calculation methods is that the parties to a transaction will not know the interest rate to be applied during an interest accrual period before the period begins. Not knowing the amount of the next interest payment may create operational issues for some corporate treasurers and others. The NY Fed is now publishing indicative forward looking term SOFR on its website. However, these indicative rates are not intended to be used in financial instruments. See https://www.federalreserve.gov/econres/notes/feds-notes/indicative-forward-looking-sofr-term-rates-accessible-20190419.htm.
The ARRC periodically published newsletter with key news updates relating to the LIBOR transition and can be found at https://www.newyorkfed.org/arrc/announcements.
ISDA has proposed amendments to its 2006 Definitions for derivatives contracts to incorporate fallbacks to one or more “risk free” reference rates (each a fallback rate) for certain key IBORs (relevant IBORs). ISDA will also publish the 2020 IBOR Fallbacks Protocol (the Protocol) to enable market participants to amend their legacy uncleared derivatives and other contracts to include these new fallback rates. The Protocol will generally cover 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 will also publish contract templates that parties may employ to bilaterally incorporate Protocol terms or otherwise amend their contracts, and will also publish forms to enable parties include or exclude certain master agreements or transactions from the scope of coverage of the Protocol.
Once agreed, the new fallback rates will apply in the event the relevant IBOR now referenced in a contract is permanently discontinued (and/or, in the event of certain LIBOR reference rates, in the event of a “pre-cessation” event of those relevant IBORs, explained below), such that the first fallback will be to a term adjusted risk-free rate for the relevant currency, plus a spread. Based on a series of market consultations, the new ISDA definitions and Protocol will also include fallback rates in the event of a “pre-cessation” event for certain LIBOR rates, including GBP, EUR, CHF, FRA, JPY and USD-LIBOR. A “pre-cessation” event is a public statement or publication of information by the regulatory supervisor for the administrator of LIBOR (currently, the UK Financial Conduct Authority) announcing that the LIBOR in the relevant currency is no longer, or will no longer be capable of being representative, or is non-representative, of the underlying market. Such announcement may be earlier in time than the end of 2021.
The amended ISDA definitions and the Protocol are projected to be published at the end of July 2020, with an effective date around November 2020 (four months following publication, such date being the protocol effective date). Parties may adhere later in time than November, but their adherence will serve to amend protocol covered agreements executed prior to the protocol effective date, and upon cessation, will have the effect of applying the relevant spread adjustment. Adherence to the Protocol will be deemed effective on the implementation date, the date ISDA accepts both adherence letters following the later of two parties’ adherence. The reference rate amendments contemplated in the Protocol will be effective on the later of the implementation date and the protocol effective date.
As mentioned above, most of the relevant IBORs’ fallback rates will include a spread adjustment in order to endeavor to preserve the economic effect of the original swap transaction. The spread component will be determined by Bloomberg® on the date of the public statement or publication of information that constitutes permanent cessation (or pre-cessation, as the case may be), and will be based on a historical median over a five-year lookback period calculating the difference between the relevant IBOR and its risk-free rate replacement.
ISDA is in the process of completing its ISDA 2020 IBOR Fallbacks Protocol FAQ. The FAQ and additional information will be made available by ISDA to the public on its website in July 2020. [https://www.isda.org/protocols]
Yes. Even though LIBOR may continue to exist until December 31, 2021, planning has already begun to migrate away from LIBOR to one or more replacement rates. We are assessing impacts, managing the LIBOR transition and seeking to mitigate risks. Our clients will hear more from us as transition tools, methods and timing become clearer.
(1) Learn more about LIBOR cessation, transition and replacement rate developments; (2) analyze your LIBOR exposure with a focus on financial instruments maturing beyond 2021 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.
Follow these links for news and other resources from some of the key industry participants in LIBOR transition:
Recent Industry Updates
Proposed Path Outlines a Clear End Date for USD LIBOR; Would End New Issuances by End-2021, and Subject to Consultation Outcomes, Legacy Contracts Could Mature by Mid-2023
The Alternative Reference Rates Committee (ARRC) today applauded concurrent announcements by LIBOR’s administrator, its regulator, and U.S. regulators, regarding the proposed path forward for the transition away from U.S. Dollar (USD) LIBOR. The announcements include supervisory guidance encouraging banks to stop new USD LIBOR issuances by the end of 2021. They also cite plans to consult on specific timing for ceasing the publication of USD LIBOR, with proposed end dates immediately following the December 31, 2021 publication for the one week and two month USD LIBOR settings, and the June 30, 2023 publication for other USD LIBOR tenors.
TO SOFR OR NOT TO SOFR?
The OCC, Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation issued an Interagency Statement on Reference Rates for Loans reiterating that they are not endorsing a specific replacement rate for LIBOR. Banks may use any reference rate for loans they determine to be appropriate for their funding models and customer needs. The agencies said banks should include language in lending contracts that provides for using a robust fallback rate if the initial reference rate is discontinued.
Capital & Liquidity Memo Published
The ARRC published a memo summarizing its preliminary findings and recommendations about potential regulatory considerations associated with applying current and anticipated capital and liquidity requirements to the LIBOR transition.
ISDA announced the launch of the IBOR Fallbacks Supplement and IBOR Fallbacks Protocol, providing a framework for transitioning USD LIBOR interest rate derivatives to SOFR. 257 derivatives market participants signed on to the Protocol during a two-week "escrow" period.
Following four Credit Sensitivity work shops,official-sector leaders released a letter stating they do not plan to recommend a credit sensitive supplement to SOFR or credit-sensitive rates. They plan to hold two additional working sessions to further discuss the subject and explore related commercial loan transition solutions.
Freddie Mac issued its first SOFR-linked credit risk transfer deal (STACR REMIC 2020-DNA5) that uses 30-day average SOFR, but Freddie Mac intends to transition the transaction to an IOSCO compliant one-month term SOFR if and when it becomes available.
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Disclaimer: The information provided on this website is provided for informational purposes only, is not intended to be exhaustive and does not constitute, and should not be relied upon as, legal, regulatory, financial, tax, accounting or other advice. MUFG is not providing any such advice and you should consult with your own advisors on the impact of the potential cessation of LIBOR on your business and affairs. The areas and issues covered by this website are continually evolving and you should consult the relevant sources. Links to some of the relevant working and trade groups are incorporated in the information included on this website.