Preparing for the transition from IBOR to risk free rates.
Interbank Offered Rates (IBORs), such as the London Interbank Offered Rate (LIBOR), have been used to set interest rates on a global basis for a wide variety of financial products, including derivatives, loans, bonds and structured products. However, as you may be aware, a number of central banks and international financial authorities have taken the view that these interest rate benchmarks represent a potential systemic risk and therefore need to be replaced or reformed. In particular:
- LIBOR is scheduled to follow different paths, depending on the currency. The FCA announced on 5 March 2021 the following cessation or non-representativeness dates:
- EUR, CHF, JPY & GBP LIBOR settings and USD LIBOR settings 1-week and 2-month will cease to be published and lose representativeness immediately after 31 December 2021.
- Remaining USD LIBOR settings will cease to be published and lose representativeness immediately after 30 June 2023.
- EONIA (Euro Overnight Index Average) was reformed in October 2019 and will be discontinued on 3 January 2022; and
- EURIBOR (Euro InterBank Offered Rate) was reformed in 2019 and is now compliant with the European benchmark regulation. ESMA will substitute the Belgian FSMA as supervisor of EURIBOR in January 2022 and ESMA stated that “as of today, the discontinuation of EURIBOR is not part of our plans. So, ahead of us there are diverging paths for LIBOR and EURIBOR”
In a number of key jurisdictions (including the US and the UK), regulators have a strong preference for LIBOR to be replaced by rates based on overnight risk-free rates (RFRs).
Regulators have confirmed that the transition went well for EUR, GBP, JPY and CHF LIBOR and require all market participants to focus their efforts to migrate their legacy USD LIBOR contracts and to control any new use of USD LIBOR.
Several regulators, including the US Federal Reserve Board [link], the UK Financial Conduct Authority [link] the European Supervisory Authorities [link] and the Monetary Authority of Singapore [link] (the “Supervisors”) issued guidance restricting banks from entering into new contracts, including derivatives, that use USD LIBOR as a reference rate after December 31, 2021.
The Supervisors identified certain limited circumstances in which it may be appropriate for a bank to enter into a new USD LIBOR contracts after December 31, 2021. These limited circumstances include market making in support of client activity related to USD LIBOR transactions executed before January 1, 2022 and transactions that reduce or hedge the bank’s or any of its clients’ USD LIBOR exposure on contracts entered into before January 1, 2022.
In accordance with the foregoing, Société Générale (together with its affiliates, “SG”) expects that any requests from you to enter into new USD LIBOR cash or derivatives transactions on or after January 1, 2022 will either support or be for the purpose of reducing or hedging your USD LIBOR exposures on contracts that you entered into prior to January 1, 2022.
SG expects that any request from you to enter into a new USD LIBOR contracts on or after January 1, 2022 shall be deemed to be a representation by you that the transaction falls into one or more of the exceptions above.
Based on regulatory recommendations and contractual license terms with CME, trading derivatives referencing CME TERM SOFR is restricted: CME TERM SOFR derivatives are permitted only:
- with end-users hedging a cash product referencing CME SOFR Term,
- with Banks that do not make markets in the interdealer market or make two-way prices in interest rate derivatives
Societe Generale is fully aware of these challenges and we are actively involved in industry efforts to manage the transition. We focus, in particular, on identifying and addressing the impacts on our clients’ transactions and on our operational capabilities.
As always, Societe Generale is committed to accompanying you throughout this transition period. We will continue to monitor industry developments and will keep you informed on the progresses and conclusions of the industry regarding the IBOR transition process.
Contact for any queries: firstname.lastname@example.org
IBOR Transition Market Updates
- October 1 2022 IBOR transition market update
- September 1 2022 IBOR transition market update
- August 1 2022 IBOR transition market update
- June/July 1 2022 IBOR transition market update
- May 1 2022 IBOR transition market update
- April 1 2022 IBOR transition market update
- March 1 2022 IBOR transition market update
- February 1 2022 IBOR transition market update
- January 1 2022 IBOR transition market update
- December 1 2021 IBOR transition market update
- November 1 2021 IBOR transition market update
- October 1 2021 IBOR transition market update
- September 1 2021 IBOR transition market update
- August 1 2021 IBOR transition market update
- July 1 2021 IBOR transition market update
- June 1 2021 IBOR transition market update
- May 1 2021 IBOR transition market update
- April 1 2021 IBOR transition market update
- March 17 2021 IBOR transition market update
- March 1 2021 IBOR transition market update
- February 1 2021 IBOR transition market update
IBOR transition background and impact
"IBOR" stands for InterBank Offered Rates. The IBOR is an average rate that is representative of the rates at which large, leading internationally active banks with access to the wholesale unsecured funding market, could fund themselves in such market in particular currencies for certain tenors. They are used to set interest rates on a global basis for a wide variety of financial products, including derivatives, loans, bonds and structured products.
ICE LIBOR (the London interbank offered rate also known as LIBOR and EURIBOR (the Euro interbank offered rate) are both examples of commonly used IBORs.
Further to the 2007 financial crisis, in particular, there was a decline in the volume of transactions on the unsecured interbank lending market. These transactions underpin IBOR rates. Due to the disappearance of these transactions, today’s daily publication of IBOR rates relies heavily on "expert judgement" instead. This means that the data used to determine the IBOR rate does no longer stem from a transaction, but from experts judging what an equivalent data could be. The public sector is concerned that this situation represents a potentially serious source of vulnerability and a systemic risk. Therefore, such IBOR rates need to be replaced or reformed. The 2014 report of the Financial Stability Board regarding IBOR rates was instrumental in kicking off this work.
Further to the Financial Stability Board recommendation in 2014, strongly relayed by Central Banks since then, LIBOR, EURIBOR and EONIA have been reformed, and work to replace LIBOR and EONIA by risk-free rates is carrying on.
On 5 March 2021, the FCA announced the future cessation and loss of representativeness of the LIBOR benchmarks , as follows:
On 31 December 2021 for GBP, JPY, CHF and EUR LIBOR, as well as for the 1 week and 2 month settings of the USD LIBOR;
On 30 June 2023 for the remaining USD LIBOR settings.
On 5 March 2021, the FCA announced the future cessation and loss of representativeness of LIBOR benchmarks(1) . This announcement has a threefold effect:
It clarifies the LIBOR wind-down timeline (see the question: “What are the main milestones of the IBOR transition”);
It provided an advance notice for the future activation of fallback clauses, that will occur upon the cessation or loss of representativeness of LIBOR;
The FCA announcement also had the effect, in relation with certain contractual triggers, of fixing the spread adjustment that will be applied to the risk-free rates fallback after the switch away from LIBOR. The calculation of these fixed spread adjustments was done by Bloomberg, and the amounts are available under: https://assets.bbhub.io/professional/sites/10/IBOR-Fallbacks-LIBOR-Cessation_Announcement_20210305.pdf
In addition, the FCA announcement confirmed that the publication of EUR and CHF LIBOR would completely cease after the announced dates. For USD, JPY and GBP LIBOR, however, the FCA opened up the possibility of a “synthetic” LIBOR being published after the cessation date. This means that on these dates the publication could carry on, at least for some time with the following changes:
Such LIBOR would no longer be based on panel banks' contributions. They would, instead, rely on a “synthetic” solution based on risk-free rates (see question: “What are synthetic LIBOR”), and
they would no longer be deemed “representative” of the underlying wholesale interbank lending market, which LIBOR reflected. This means that they could no longer safely be used for new products, although so-called “tough legacy” agreements could remain with such synthetic LIBOR. The exact definition of the products allowed to benefit from the “tough legacy” status is not known yet.
The timelines for the USD, JPY and GBP synthetic solutions would need to be further defined following FCA consultations.
However, caution is required when contemplating synthetic LIBOR. Indeed, in a speech on 22 March 2021(2) , Federal Reserve Vice Chair for Supervision, Randal K. Quarles, remarked that “no one should assume that there will be a synthetic USD LIBOR”.
On 5 March 2021, the FCA announcement confirmed that there was, for some settings of the USD, GBP and JPY LIBOR, a possibility of a “synthetic” LIBOR being published after the announced cessation date (see question: “What is the effect of the FCA announcement of 5 March 2021?”).
Such synthetic LIBOR would be based on a new methodology that would be defined through consultations by the FCA. Thus, LIBOR would formally carry on for use in “tough legacy” products that would not need to “re-hitch” to a new benchmark. But its determination mechanism would have changed. Instead of panel banks contributions, LIBOR would most likely be determined by reference to the corresponding risk-free rate, the RFR OIS market and a possible spread adjustment.
Once an IBOR ceases to be published by its administrator or is declared non representative by its supervisory authority, any new transactions on such IBOR may become impossible. The move away from IBORs may also generate the need to amend some of your existing transactions maturing beyond 2021 (or beyond June 2023 for the most used USD LIBOR tenors), in order to replace IBORs with new interest rate benchmarks, such as risk-free rates, that can be recommended by the central bank working group for the concerned currency.
As advised by supervisory authorities, it is important to prepare ahead of the IBOR transitions and to use, where possible, alternative solutions, such as risk-free rates, instead of LIBOR.
While the exact impact of the IBOR transition on products and services is not known yet, clients may wish to take certain steps to prepare for the transition:
Understand your exposures and risks, including:
Conducting a documentation review of existing contracts (with banks and non-banks, e.g. your suppliers and business partners) to identify references to IBORs or other affected interest rate benchmarks;
Assessing the need for short-term liquidity facilities;
Conducting a review of IT and other tools relying on IBOR benchmarks;
Drawing on external advice (banks, professional associations, external advisers…) to consider what steps need to be taken to ensure operational readiness;
Actively reduce your reliance on IBOR, including:
Starting transacting in products or services referencing new RFRs or other alternative solutions;
For derivative transactions, updating the contractual framework, including the migration to RFRs of Credit Support Annexes (CSAs), in order to allow for an uninterrupted management of collateral throughout the IBOR transition;
Engage with transition efforts, including:
Staying informed of industry developments;
With your suppliers, business partners or related entities, transitioning your IBOR transactions maturing after the cessation dates to alternative solutions which is the best way to avoid any issues due to the IBOR transition;
Adhering to the ISDA protocol dedicated to the IBOR transition, after checking with your external advisers.
For EUR CSA, EONIA (Euro OverNight Index Average) will no longer be published after 31 December 2021, consequently, Market participants have started to migrate their EUR CSA to €STR (Euro Short Term Rate), to remove reference to EONIA.
For USD CSA, the ARCC (Alternative Reference Rates Committee) of the FED (New York Federal Reserve) has made recommendations aiming at promoting the migration of CSAs from FED Funds to SOFR (Secured Overnight Financing Rate) for InterDealer Counterparts.
Your usual SG representative remains your key contact for any questions on CSAs.
Risk-Free rates (also known as Alternative Reference Rates)
The public sector, industry bodies and trade associations have identified risk-free rates ("RFRs") as possible replacements for IBORs. These alternative RFRs are at different stages of implementation, depending on their currency.
Risk-free rates have been identified by public sector, industry bodies and trade associations as possible replacement for Interbank Offered Rates (IBORs) as part of the ongoing IBOR transition.
The below table lists the historical IBOR rates for major currencies and the corresponding RFRs:
The main differences between IBORs and RFRs are the following:
Whereas IBORs are forward looking term rates that can apply across multiple tenors: overnight, 1 week, 1 month, 2 months, 3 months, 6 months and 12 months, RFRs are overnight rates with no term element (no maturities). The only possibility to use RFRs with tenors, as of now, is on a backward-looking basis, as averages over a given past period. The methodology recommended by public authorities and working groups to calculate such averages is with compounded interests.
IBORs contain a premium for bank credit risk (and potentially other premiums – liquidity, term and funding) whereas, in general, RFRs contain little or no such additional premiums;
Whilst the data for the determination of IBORs stems from transactions, but also from expert judgement in case of insufficient transactions, RFRs rely exclusively on transactions.
While LIBOR are structurally “forward-looking”, with their tenors set at the beginning of the interest period over up to 12 months, RFRs are overnight benchmarks. For practical matters, the most common way of using RFRs relies on a “backward-looking” compounding of interests, at the end of the interest period, determined with daily RFR fixings. These two approaches of time (forward vs. backward-looking) entail significant operational differences between both benchmarks, with commensurate difficulties:
Because of the operational difficulty related to this forward vs backward mechanism, several industry working groups organized by central banks have declared that they wish to propose a forward looking RFR term structure. Such term structure would allow to modify the backward-looking use of RFRs, in order to equip them with a forward-looking dimension. So far, only the term structure for SONIA is available, since January 2021.
The sterling working group identified supply chain finance, receivables financing and export financing and emerging market loans as sectors that would most benefit from a Term SONIA.
Risk-free rates are not mandatory alternative solutions for LIBOR or EONIA. Other alternative solutions are available, such as fixed rates (for those users that need certainty about their payments) or benchmarks other than LIBOR or EONIA.
Borrowers that wish to retain the advance knowledge of their interest payment, while avoiding the potential reliability issues of RFR term structures, may want to consider fixed rates (which by construct are always known in advance) as an alternative to IBORs.
The desire to develop forward-looking RFR term rates has been expressed by a number of industry working groups or private companies. SONIA (GBP) is the first RFR where a term rate became available, in January 2021. However, UK authorities have clearly stated that the use of such benchmark will be limited(1) . SONIA compounded in arrears is expected to be the primary vehicle for LIBOR transition. The use of a term SONIA reference rate is to be restricted to very specific cases:
For new transactions: Trade & working capital products, export finance / emerging market loans;
For legacy transactions: For legacy LIBOR transactions that cannot easily be amended to overnight rates compounded in arrears, or for deals where their short remaining maturity would not make it cost effective to transition to SONIA compounded in arrears.
Regarding forward-looking RFRs for the other LIBOR currencies:
USD: The ARRC (the working group with the NY Federal Reserve Bank) is working on a forward-looking SOFR term rate that could perhaps become available by late 2021;
JPY: The Bank of Japan’s working group is assessing the possibility to provide a forward looking TONA term rate;
CHF: The working group of the Swiss National Bank has made it known that there would be no forward-looking term rate for SARON;
EUR: The European Central Bank working group is assessing the possibility to provide a forward looking €STR term rate.
The IBOR transition is not a one-to-one benchmark replacement. IBOR rates include a bank credit premium and a term liquidity premium, whereas risk-free rates do not. Consequently, IBOR benchmarks and risk-free rates may not have the same fixing level. In other words, the interest rate applicable to a given transaction may not be the same under an IBOR benchmark and under an RFR. This gap entails an economic risk at the time of transitioning, and a potential transfer of economic value from one party to the other. This risk can be mitigated with appropriate mechanisms such as the addition of an adjustment spread to the risk-free rate compensating for the historical difference with the IBOR.
The RFR working groups are aware of the issue and are working on it. As stated by the Working Group on euro risk-free rates, in its revised report on the transition from EONIA to €STR (March 2019): “A successful transition path would also […] protect users, especially the least sophisticated, by mitigating potential value transfers in the system.” Therefore, in order to recommend the best possible transition approach, the Working Group has considered different criteria, including for economic risks: “a potential value transfer as a result of the benchmark transition from EONIA to €STR should be mitigated to the maximum extent possible.”
Many countries are thinking about introducing RFRs for their currency. Below table provides example of RFRs in Asia and elsewhere.
Societe Generale has developed RFR-based products, please contact your usual SG contact to learn more about offered products.
A “fallback clause” provides for a contractual replacement solution in case the IBOR rate in an agreement should disappear on a permanent basis, or, depending on the drafting of the clause, in case the IBOR is declared to be “non representative” by a competent authority. The purpose is to ensure the continuation of the agreement at the time of discontinuation or non-representativeness of the IBOR rate.
To date, fallback clauses are considered as mitigating the risk of abrupt contract termination, upon the cessation of an IBOR publication. However, fallback clauses are not a panacea. As Andrew Bailey, when he still was Chief Executive of the Financial Conduct Authority, put it: “Fallback language to support contract continuity or enable conversion of contracts if LIBOR ceases is an essential safety net – a 'seat belt' in case of a crash when LIBOR reaches the end of the road. But fallbacks are not designed as, and should not be relied upon, as the primary mechanism for transition. The wise driver steers a course to avoid a crash rather than relying on a seatbelt.”
Indeed, fallback clauses entail many difficulties. One is the quality of the replacement rate, which depends on each agreement, and which may be suboptimal, especially in older contracts. Another one is the risk of de-synchronised transition (see previous question “I am a client with different IBOR products. Will the transition be the same for all my products?”).
This is why it is recommended to anticipate, at two levels:
By including robust fallback clauses in all new IBOR agreements, and
By re-negotiating IBOR agreements upfront, in order to move them to alternative solutions prior to the end of an IBOR benchmark, and without awaiting the trigger of a fallback clause.
For derivative products under ISDA or ISDA-related master agreements, the best way to update the fallback clauses is to adhere to the new ISDA IBOR Protocol(1).
Societe Generale is here to assist customers diligently moving their agreements away from IBOR benchmarks.
For derivative products governed by the ISDA 2006 Definitions, a new fallback provision (the ISDA 2020 IBOR Fallbacks protocol) applies since 25 January 2021. The purpose is to provide ISDA documentation users with a hardwired fallback mechanism triggered at the time of cessation of an IBOR, or when it is declared non-representative of the underlying market.
The ISDA fallback rate is made up of 2 items:
The RFR compounded in arrears over the correspondent tenor of the replaced IBOR rate; plus
A spread adjustment corresponding to the median of the historical daily difference between IBOR and the compounded in arrears RFR, as observed over a 5-year period.
This historical spread adjustment is necessary to compensate for the difference between the IBOR and the compounded RFR, in order to avoid value transfers between counterparties. The calculation of these fixed spread adjustments was done by Bloomberg, and the amounts are available under: https://assets.bbhub.io/professional/sites/10/IBOR-Fallbacks-LIBOR-Cessation_Announcement_20210305.pdf
As a practical matter, Bloomberg has been selected to publish the value of the ISDA fallbacks for each IBOR and maturity. Bloomberg and ISDA announced on 21 July 2020 that Bloomberg has begun calculating and publishing fallbacks that ISDA intends to implement for certain key interbank offered rates (IBORs).
From 25 January 2021 onwards, this ISDA mechanism will apply both to the new transactions (via the ISDA IBOR Supplement) and to the legacy agreements (via the ISDA IBOR Protocol, if both parties have adhered to it) governed by the ISDA Definitions.
Further information on the ISDA fallback mechanism is available under:
As recommended by public authorities, Societe Generale did adhere to the ISDA 2020 IBOR fallback protocol in order to mitigate the risk of abrupt contract termination, upon the cessation of an IBOR publication.
The ISDA protocol is a safety net to ensure that derivative products are not left without a transition solution upon cessation of an IBOR publication.
As the scenarios for winding down LIBOR become clearer over time, it appears that the different transition paths that may exist for different IBOR products tend to converge towards very similar solutions, in the case of alternative reference rates. This is the result of a tight coordination of the IBOR transition at international level across the whole banking industry.
Therefore, the risk of a “de-synchronised” transition, whereby all products or services do not necessarily transition at exactly the same time and in the same way, have largely subdued.
A frequent example of such de-synchronisation is where a customer has two related products: a variable interest loan and the corresponding hedging instrument. In case the loan does not transition to a RFR in exactly the same way than the hedge (often governed by the ISDA Definitions), there arose the risk of a mismatch between the loan and its hedge. But due to the similarity of the RFR solutions across products, this risk has largely diminished. However, your usual SG contact can help you assess and mitigate the risk by reviewing the loan and the hedging instrument and verifying what adjustments need to be made. A possible solution would be to renegotiate the loan and the hedging instrument at the same time.
For “tough” legacy agreements, i.e. legacy agreements without adequate fallback solutions, public authorities are currently working on statutory safety nets:
The EU recently empowered the European Commission, further to an amendment of the European Benchmark Regulation, to impose statutory replacement rates as a default solution for agreements without adequate fallback. It is not known yet how the Commission will use its powers;
In the US, a Bill under State of New York law could also provide for a statutory replacement rate;
The UK took a different approach and the FCA is empowered to propose a “synthetic” continuation of certain LIBOR on a temporary basis past the announced end date. This solution is still under discussion and will, in any event, not be available for CHF LIBOR nor for EUR LIBOR.
Links to central bank working groups
- New York Federal Reserve (USD) : Alternative Reference Rates Committee (ARRC)
- Bank of England (GBP) : Working Group on Sterling Risk-Free Reference Rates
- Swiss National Bank (CHF) : National Working Group on Swiss Franc Reference Rates
- European Central Bank (EUR) : Working Group on Euro Risk-Free Rates
- Bank of Japan (JPY) : Study Group on Risk Free Rates
- European Central Bank (€STR): https://www.ecb.europa.eu/stats/financial_markets_and_interest_rates/euro_short-term_rate/html/index.en.html
- Bank of England (SONIA): https://www.bankofengland.co.uk/markets/sonia-benchmark
- New York Federal Reserve (SOFR): https://apps.newyorkfed.org/markets/autorates/sofr
- Bank of Japan (TONAR): https://www3.boj.or.jp/market/en/menu_m.htm
- Swiss Stock Exchange SIX (SARON): https://www.six-group.com/exchanges/indices/data_centre/swiss_reference_rates/reference_rates_en.html
This webpage dedicated to the IBOR reform, including the Q&A, has been prepared by Societe Generale (SG). The information it contains is general and does not constitute advice. It was first prepared prior to the date it is published and may not have been updated to reflect recent market developments. It contains information on IBOR reform that is intended for the use of SG clients only and it should not be shared with third parties. SG accepts no responsibility or liability to you with respect to the use of this webpage or its contents. If you have questions in relation to the contents of this webpage, you should consider seeking independent professional advice (legal, tax, accounting, financial or other) as appropriate.
ICE LIBOR is a registered trademark of ICE Benchmark Administration Limited, a subsidiary of Intercontinental Exchange, Inc.
Bloomberg is a registered trademark and service mark of Bloomberg Finance LP.
ISDA is registered trademark and service mark of the International Swaps and Derivatives Association, Inc.
Euribor and Eonia are registered trademarks of EMMI a.i.s.b.l.
SARON is a registered or pending trademark of the SIX Swiss Exchange.