LIBOR’s swan song

Borrowers and investors have not long left to complete transitions before the end of non-US dollar London Interbank Offered Rate (LIBOR) as the key interest-rate benchmark for loans, bonds and derivatives.

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While some firms have commenced or completed transitions, and others have clear plans to do so, there are others still who have yet to commence their preparations. It is now time to engage with their financial institutions to ensure a smooth transition.

LIBOR currently underpins over $US400 trillion worth of loans, bonds, derivatives and other financial instruments. But doubts surfaced following the global financial crisis about LIBOR’s integrity and reliability after cases of market manipulation emerged. Although the first public exposure was in 2012 there is evidence the gaming of the benchmark stretched back nearly a decade.

2014 study by the Financial Stability Board (FSB) into the reliability and robustness of interbank benchmarks recommended the development of alternative benchmarks, with a preference for use of nearly risk-free rates (RFRs).

A major issue with LIBOR was it didn’t reflect actual transactions rather the estimates of a panel of banks of a hypothetical rate they would expect to pay at a given time.

National working groups were set up in each country to identify and develop strategies to enable the  transition to these RFRs. Meanwhile the UK’s Financial Conduct Authority (FCA), that oversees the administrator of LIBOR, concluded LIBOR was unsustainable. The FCA announced in 2017 it would no longer compel panel banks to submit LIBOR estimates after December 2021, effectively giving LIBOR an expiry date. 

In December 2020, a consultation by the administrator of LIBOR was announced to consider whether US dollar LIBOR would continue until June 2023, while the non-US dollar currencies, namely Japanese yen, euro, British pound and Swiss franc, would cease on December 31 2021. On March 5 the cessation announcement from the ICE Benchmark Administration and FCA effectively locked in the end dates for LIBOR and started the deadline clock ticking.

Industry recommendations

The transition from one operating state to another always involves uncertainty and some risk – and the transition away from LIBOR is no exception. With working groups and regulators in each jurisdiction making decisions and recommendations that apply to benchmark rates for their currency, coupled with how the new rates will be used in different financial products, the transition away from LIBOR was always going to be complex.

Through extensive industry consultation by the national working groups (such as ARRCUKRFRWG and SC-STS) and industry bodies (such as ISDALMALSTA and APLMA) preferred or recommended approaches have evolved over the past few years. These recommendations are however just that. They guide industry on the likely approaches to transition and conventions for the use of RFRs.

The derivatives market via ISDA moved to provide the safety net of robust fallbacks via the ISDA IBOR Fallbacks Supplement and associated Protocol. In the loan markets, it is only in recent months transitions have commenced in earnest and the industry conventions have become more commonly agreed and adopted by most parties.

Each lender should provide borrowers with details of their proposed replacement products and be able to explain how the transition away from LIBOR is fair to both parties, as is required by global regulators.

Key considerations

In an RFR environment, each additional currency adds complexity to cash product transaction documentation. As such, borrowers should carefully consider which currencies they wish, or need, to have funding available in.

For some borrowers, who previously had “multi” or “all currency” wording in loan documentation, a simple solution could be to remove some or all of the LIBOR currencies.

Borrowers who still want access to US dollar funding but not in the other LIBOR currencies could defer transition of their loan facilities until 2022 by removing the other currencies or restricting their ability to drawdown in those currencies.

Borrowers could then continue to fund in existing facilities referencing US dollar LIBOR and make the transition when market conventions in the US dollar market are more settled. Regulators in the US have recommended no new US dollar LIBOR products should be entered into after the end of 2021, with certain exceptions for derivatives being used for risk management.

Those who fund or invest in LIBOR referencing cash products and use derivatives to hedge their exposures need to pay careful attention to the market conventions evolving in different RFR products to avoid any unnecessary basis risks.

Booking, risk, operations and finance systems will likely need to be modified to incorporate the new reference rates, fallback rates and calculation methods. Such changes often require project management and due diligence and have a significant lead time to implement.

Impacted firms also need to identify any accounting, tax and legal implications from the transition and take steps to manage these risks.

Term RFRs

In late July 2021, the ARRC endorsed the CME SOFR Term Rate, removing one of the last major hurdles for global markets to make the transition. The decision will make it easier for borrowers who have US dollar liabilities to shift away from LIBOR. A term rate is more like LIBOR, providing more cash flow certainty and requires fewer system changes than compounded RFRs.

Further Term SOFR has been recommended by the ARRC for use in US dollar-based business loans and multi-lender facilities. This differs from the FCA in the UK which has limited the use case for Term SONIA in British pound-denominated products to trade finance, emerging markets and the retail market. Term SONIA is not available for corporate lending.

The Bank of Japan has endorsed TORF as the term rate in Japan without any use case restrictions. There is no term RFR available for Swiss franc and euro-denominated products, although Euribor continues to be published and fills that role for the Euro market.

Industry is working through the implications of the different use cases for term rates and is preparing for a more widespread use of Term SOFR. The differences of approach to term rates between USD, GBP and JPY will result in multi-currency products becoming more complex. Careful analysis of your specific currency requirements should be completed as a priority

Avoid the rush

The time it has taken for industry to settle on preferred replacement products has left a relatively short period for both borrowers and lenders to move their legacy products and transactions away from LIBOR.

Although best efforts are being directed to manage the anticipated workload by industry, firms should act now, engage with their counterparties, make the necessary preparations and seek to avoid getting caught up in the rush to exit LIBOR.


Duncan Marshall is LIBOR Transition-Business Lead and David Doyle is LIBOR Transition-Communications Lead at ANZ Institutional 


This article was originally published on ANZ’s Institutional website

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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