IBOR Transition

"IBOR" stands for InterBank Offered Rates. The IBOR is an average rate that is representative of the rates at which large, leading and 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) is an example 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 needed to be replaced or reformed. The 2014 report of the Financial Stability Board regarding IBOR rates was instrumental in the launching of this initiative.

On 5 March 2021, the FCA announced as supervisor the cessation and loss of representativeness of the LIBOR benchmarks, as follows: 

• Definitive cessation following 31 December 2021: (i) all settings of CHF and EUR LIBOR, (ii) all settings of GBP and JPY LIBOR except 1,3 and 6 months settings that continued to be published under a new methodology (Synthetic LIBOR), (iii) 1 week and 2 months settings of USF LIBOR while the remaining settings will be published until 30 June 2023. 

This announcement has a threefold effect: 

• It clarifies the LIBOR wind-down timeline,

• it provided an advance notice for the activation of fallbacks clauses that triggers 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 applies to the risk-free rates fallback after the switch away from LIBOR. The calculation of these fixed spread adjustments was done by Bloomberg and are available under:  https://assets.bbhub.io/professional/sites/10/IBOR-Fallbacks-LIBOR-Cessation_Announcement_20210305.pdf.pdf

   

   

On 29 September 2021, the FCA has decided to exercise its power to compel the continued publication of the 1M, 3M and 6M GBP and JPY LIBOR settings for a limited period using a synthetic methodology. 

The FCA has also comfirmed the changed methodology (instead of panel banks contributions) for calculating these rates: 

• for 1,3 and 6 month GBP LIBOR, the relevant ICE Term SONIA Reference Rate provided by IBA and for 1,3 and 6-month JPY LIBOR, the Tokyo Term Risk Free Rates (TORF) provided by QUICK Benchmarks Inc (adjusted to be on a 360-day count basis); plus

• the respective ISDA fixed spread adjustments (that is published for the purpose of ISDA's IBOR Fallbacks Supplement and Protocol) for each of these six LIBOR settings. 

The FCA announced the final LIBOR publication:

• the 3 synthetic JPY LIBOR settings ceased at end 2022

• synthetic GBP LIBOR for 1 and 6 month will cease at end March 2023 and the 3-month will cease at end March 2024. 

• Proposal to require LIBOR's administrator, IBA, to continue to publish the 1,3 and 6 months US Dollar IBOR settings under an unrepresentative "synthetic" methology until end of September 2024. 

The eventual use is limited to ‘tough legacy’ transactions only. Synthetic rate is not representative and thus cannot be considered as a permanent solution.

The synthetic methodology has been chosen by the FCA to provide a reasonable and fair approximation of what the panel bank contributed Libor might have been in the future. The historical contributed Libor methodology dynamically reflected a fluctuating interbank term credit premium while the 'synthetic' methodology incorporates this premium statically through the ISDA fixed adjustment spread calculated based on five years historical data. Consequently, FCA declared that ‘synthetic’ Libor remains unrepresentative of the underlying market and economic reality that Libor was intended to measure

As stated by the FCA, Synthetic LIBOR is, therefore, not a permanent solution and the use of 'synthetic 'Libor is limited to transactions that could not be renegotiated as of date Libor lost representativeness. Such transactions should be transitioned to alternative rate as soon as practically possible afterward.

No, synthetic LIBOR is intended to be used solely for contracts which do not have a fallback provision or have not been renegotiated before 31 December 2021. We remind that since the end of 2021 GBP and JPY LIBORs have been no longer representative for 1- , 3- and 6- months settings and have been published according to a "synthetic" methodology for a limited time period (until end-2022 for JPY Libor and until March-2023 for 1- and 6-month and until March-2024 for 3-month for GBP LIBOR).

As advised by supervisory authorities, it is important to be prepared ahead of the IBOR transitions and to use, where possible, alternative solutions, such as risk-free rates, instead of IBOR.

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.

The ARRC (ALternative Reference Rates Committee) of the FED (New York Federal Reserve) had made recommendations aiming at promoting the remuneration of USD cash collateral to SOFR (Secured Overnight Financing Rate) for interdealer transactions. 

The public sector, industry bodies and trade associations have identified risk-free rates ("RFRs") as possible replacements for IBORs. 

The landscape of all alternative solutions based on RFRs is now clear for the 5 major currencies (ongoing reflection and development of alternative solutions to other ceasing rates, e.g., Asian rates related to USD Libor).

The table below summarize the main indices (backward looking), and term rates (forward looking) based on RFRs:

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 most common way  to use RFRs with tenors 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. There are also forward-looking term rates based on RFRs, e.g Term SONIA (GBP), TORF (JPY) and TERM SOFR (USD) which can be used mostly for legacy contracts and in some instances for new contracts (scope is predetermined by the regulator for each currency)

• 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 developed term rates based on RFRs. 

The aim of developing forward-looking term rates is to have the possibility of knowing the rate at the start of the interest period as was the case with Libor fixings. These are rates based on RFRs, i.e., the market expectation of the trajectory of the RFR over a certain period, the three term rates developed are: Term SONIA, Term TONA (TORF) and Term SOFR.

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), term rates (based on RFRS) 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.

Concerning the Credit Sensitive Rates (USD Market); they are all-in rates with term structure and incorporate a dynamic credit component, however the market standard for the wholesale banking remains SOFR.

The desire to develop forward-looking RFR term rates has been expressed by a number of industry working groups or private companies.

Regarding forward-looking RFRs for the other LIBOR currencies:

• USD:On 29 July 2021 the ARRC (the working group with the NY Federal Reserve Bank)formally recommends the use of 1-month, 3-month and 6-month CME Term SOFR Rates for loan market and specified further best practices on 27 August 2021 . On 19 May 2022 the ARRC announce its endorsement of the 12-month CME term SOFR. The ARRC does not recommend the trading of Term SOFR Rate derivatives in the interdealer market except for end users hedging. (See the question 15: “What is CME Term SOFR?). ICE Benchmark Administration launched ICE Term SOFR Reference Rates as Benchmark for use in cash products.

• GBP: On 11 January 2021, the ICE Benchmark Administration launched ICE Term SONIA Reference Rate (TSRR) for use as a benchmark for use in a limited number of cash products. 

• JPY: On 21 April 2021 the official TORF (Tokyo risk free rate) is calculated and published by Quick Corp. 

• 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 Working Group on EUR Risk-Free recommends market participants include a forward looking €STR term rate-based fallback into fallback EURIBOR. Two benchmarks are available: EFTERM and Refinitiv TERM €STR (beta version) available in multiple tenors. 

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.

Societe Generale has developed RFR-based products, please contact your usual SG contact to learn more about offered products.

Many countries are planning to introduce RFRs for their currency. Below table provides examples of RFRs in Asia and eslsewhere: 

The CME Term SOFR Reference Rates is a benchmark administered by CME Group Benchmark Administration Limited that “provides an indication of the forward-looking measurement of overnight SOFR, based on market expectations implied from derivatives markets” for 1-month, 3-month, 6-month and 12-month tenors.

While the ARRC recommends SOFR for all products, and as a general principle, the use of overnight SOFR and SOFR averages given their robustness, it also highlighted areas where transitioning from LIBOR to an overnight rate has been difficult and particularly for the business loans market: multi-lender facilities, middle market loans, and trade finance loans.

However, any use of CME Term SOFR Rate derivatives should be limited to end-user facing derivatives intended to hedge cash products that reference the SOFR Term Rate.

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, parties to an IBOR transaction may want to re-negotiate before the actual fallback triggering in order to move them to alernative solutions prior to the end of an IBOR benchmark. 

The International Swaps and Derivatives Association (ISDA) has published new interest rates definitions that incorporate fallback provisions in new derivative products as well as a protocol allowing the incorporating of such fallbacks into legacy transactions. 

 The purpose of the ISDA fallbacks 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 their levels 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 fallback mechanism applies both to new ISDA transactions (unless specifically excluded) and to legacy transactions governed by the ISDA definitions if both parties have adhreed to the ISDA IBOR Protocol. 

Further information on the ISDA fallback mechanism is available under:

•  https://www.isda.org/protocol/isda-2020-ibor-fallbacks-protocol/

• https://www.bloomberg.com/professional/solution/libor-transition/

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. 

Furthermore, SG did adhere to additional Benchmark Module published by ISDA to enable parties Protocol Covered Documents which incorporate or reference the USD LIBOR ICE Swap Rate.

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-synchronized” 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-synchronization 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 have developed statutory solutions as safety nets:

• The European Commission adopted on 21 October 2021 the designation of a statutory replacement of EONIA. The commission appointed "€STR + 8.5 basis points" as the replacement rate for EONIA for all contracts, that does not contain suitable fallback provisions. 

• The European Commission designated on 14 October 2021 a statutory replacement for certain settings of CHF LIBOR. (1) the 1M SARON compound Last reset will replace the 1M CHF LIBOR; while the 3M SARON compound Rate will replace the 3M, 6M and 12M CHF LIBORS. (2) A fixed spread adjustment shall be added to the designated replacement rates. 

• In the US, The Board of Governors of the US Federal Reserve System implemented the Adjustable Interest Rate (LIBOR) Act. The purpose of the LIBOR Act is to provide a US Federal framework that mitigates risks and provides continuity for certain contracts that reference the overnight, 1-, 3-, 6-, or 12-month tenors of USD LIBOR. Where applicable, this statutory regime aims at replacing the USD LIBOR with SOFR plus the ISDA published spread for derivatives products and with CME Term SOFR plus the ISDA published spread for cash products entered into under a US law.

The ICE Swap Rates or commonly referred to as CMS rates are built from swap rates linked to Libor. Due to the cessation of these benchmarks, Supplements have been added to ISDA-Definitions to incorporate Fallbacks for GBP, JPY and USD ICE Swap Rates.

Furthermore, to support the transition to RFRs new Swap Rates are now published based on RFRs: GBP SONIA ICE Swap Rates, USD SOFR ICE Swap Rates, and JPY Refinitiv Tokyo Swap Rate.