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Preparing for Interbank Offered Rate (IBOR) Transition

Preparing for benchmark interest rate reform

Benchmark interest rates are widely used across the global economy for calculating interest rates and valuations in relation to a wide variety of financial contracts, such as derivatives, bonds, loans, consumer lending products.

Global regulators are concerned about the robustness of benchmark interest rates such as LIBOR and expect market participants to plan for no LIBOR publication after the end of 2021.

  • Background

    For several years, global regulators and central banks have been driving international efforts to reform key benchmark interest rates to make them more reliable. These reforms are happening in many jurisdictions, such as the United Kingdom, the Euro area, the United States, Switzerland, Canada, Japan, Hong Kong, Singapore and Australia.

    A key focus of these reforms is to ensure that widely used benchmarks are credible and robust. Regulators have been clear that this means benchmarks should be based upon transactions to the greatest extent possible. 

    In July 2014, the Financial Stability Board, an international body that monitors and makes recommendations intended to promote financial stability, issued a report expressing concerns about the ‘reliability and robustness of existing interbank benchmark rates.  The Financial Stability Board recommended a two pronged approach to reform benchmarks.

    1. Strengthen existing Interbank Offered Rates (IBORs) by underpinning them to the greatest extent possible with transactions data
    2. Develop alternative, nearly risk-free reference rates (RFRs)

    What is LIBOR & why is it being replaced?
    The London Interbank Offered Rate (“LIBOR”) is a daily benchmark interest rate calculated as an average of panel bank submissions and provides indication on the rate banks pay to borrow unsecured money across five currencies (British Pound Sterling, Euro, Japanese Yen, Swiss Franc and US Dollar) and seven tenors (overnight, 1 week, 1, 2, 3, 6 and 12 months) and used for the purposes of financial contracts, as a reference rate; including for calculating interest. Its administrator, ICE Benchmark Administration (IBA), publishes LIBOR rates every applicable London business day. LIBOR is widely used across the global economy for calculating interest rates and valuations in relation to a wide variety of contracts, such as derivatives, bonds, loans and consumer lending products.

    Despite reforms in the governance and submission methodology of LIBOR, which now anchor the benchmark in “transactions to the greatest extent possible”, few transactions in the short-term money market actually occur now as banks have changed the way they fund themselves. Regulatory measures implemented after the 2008 financial crisis, to strengthen banks’ balance sheets, have reduced the utility of unsecured interbank borrowing in the money markets. These are the same transactions upon which LIBOR submissions are based.

    Regulators’ concerns about the continued use of LIBOR remain elevated. In a key regulatory speech in 2017, the Chief Executive of the Financial Conduct Authority (FCA), Andrew Bailey, clearly articulated the continuation of LIBOR was at risk: “Our intention is that, at the end of [2021], it would no longer be necessary for the FCA to persuade, or compel, banks to submit to LIBOR.  It would therefore no longer be necessary for us to sustain the benchmark through our influence or legal powers.”

    More recently at an Alternate Reference Rate Committee Roundtable speech in 2019, Randal Quarles, Chair of The Financial Stability Board, stressed that the “ Clarity on the exact timing and nature of the LIBOR stop is still to come, but the regulator of LIBOR has said that it is a matter of how LIBOR will end rather than if it will end, and it is hard to see how one could be clearer than that.”

  • What is replacing LIBOR

    Global regulators formed currency-specific working groups to assess market conditions, examine alternatives and consider next steps. Members of these working groups include banks, asset managers, insurance companies, and corporates. Industry bodies and trade associations representing various segments of the market are also actively engaged.

    These efforts have resulted in the identification of Risk-Free-Rates (RFRs), for each of the LIBOR currencies, which are based upon overnight transactions; however, these are not the only identified alternatives. While it is expected that RFRs will become the norm for derivatives, securities and wholesale loans, regulators have highlighted the usage of other variable rates or fixed rates for some market participants.  An example of this in the UK, is the Bank of England Bank Rate, which is already widely used in mortgages and for some retail lending where simplicity and transparency of the rate are seen as priority. 

    Currency Existing Rate Alternative Rate Transaction Type
    USD LIBOR SOFR, Secured overnight financing rate Secured
    EUR* LIBOR, EURIBOR €STR, Euro short term rate Unsecured
    GBP LIBOR SONIA, Sterling overnight index average Unsecured
    JPY LIBOR TONA, Tokyo overnight average Unsecured
    CHF LIBOR SARON, Swiss average rate overnight Secured

    The Euro Short Term Rate (“€STR”) is intended to replace the Euro Overnight Index Average (“EONIA”), at the end of 2021. No potential cessation date has been given for EURIBOR 
    For information on other key jurisdictions please download our world map (PDF 315KB)

    What is happening with EURIBOR & EONIA?

    EURIBOR, (EURO Interbank Offered Rate) completed reforms of its methodology in Q4 2019. The European authorities believe reformed EURIBOR can exist beyond 2021, and no indication has been given that the benchmark is likely to cease anytime soon. However, EONIA, the Euro Overnight Index Average, became increasingly fragile in recent years. Consequently, the methodology was changed in October 2019 and EONIA became a tracker rate to €STR, the RFR identified by the Euro working group. It is expected publication of EONIA will cease on 3 January 2022.

    What are RFRs?

    The acronym “RFR” was introduced by the Financial Stability Board in their 22 July 2014 publication on benchmark interest rate reform.  The phrases ‘near risk-free rates’, ‘risk-free rates’ and ‘alternative reference rates’ are generally accepted as interchangeable and these should be considered to refer to the same: reference rates which are being developed by international, central bank led working groups as alternatives to LIBOR.

    RFRs have a number of differences when compared to LIBOR, including:

    • Each currency has its own distinct RFR and administrator;
    • RFRs are overnight rates, not rates for a longer term such as three or six months. As such, there is very little perceived credit risk or term premium associated with RFRs;
    • Some market participants have expressed the need for a RFR based term rate, in order to know the applicable interest rate in advance of any payments to be made. Each of the RFR working groups is considering if it will be feasible to produce a robust term rate. The Swiss group has stated it will not be possible in that market;
    • RFRs are based on a large number of overnight money market transactions, so the risks associated with expert judgment do not arise;
    • The underlying volumes representing the indices which determine the RFRs are much higher than LIBOR;
    • Whilst all LIBORs are unsecured rates not backed by any exchange of collateral, two of the five RFR working groups selected secured, or collateralised, rates for their respective currencies based on transactions in their respective government security repo markets.
  • What is Barclays doing to prepare for LIBOR Transition
    • Barclays supports the benchmark interest rate reform agenda as set out by the Financial Stability Board in 2014 and subsequently driven by the international risk free rate working groups and relevant supervisory authorities.  We are actively engaged in the reform agenda and along with participating in various industry conferences and events discussing LIBOR transition, Barclays is a member of the US, EU, Japan and Singapore working groups. More prominently, Barclays chairs the Working Group on Sterling Risk-Free References Rates.
    • As instructed by the Bank of England Prudential Regulatory Authority and the UK Financial Conduct Authority, Barclays is planning for the base case scenario that LIBOR will no longer be available after 2021.
    • Barclays has mobilised an enterprise-wide programme with Senior Manager oversight, to coordinate its global efforts in relation to the transition.
    • Barclays is also aware that transition to RFRs is at different stages depending on the jurisdiction, and moving at different speeds. This also applies to the potential development of RFR-based term rates. 
    • Barclays expects that the timing of any transition away from relevant interbank offered rates to take into account liquidity in the replacement RFR, the potential development of robust RFR-based term rates, development of any relevant industry conventions and the speed with which participants in the various derivative, bond and lending markets transition away from LIBOR.

     Corporate and Investment Bank Clients

    In a communication recently sent to clients of the Corporate and Investment Bank, we highlight some of the risks market participants should consider and suggest steps to take now to prepare.

    For more information on Corporate Banking Products please visit our website.

    Private Bank Clients

    In a communication recently sent to clients of the Private Bank, we highlight some of the risks market participants should consider and suggest steps to take now to prepare.

  • What should market participants do to prepare

    Given the use of LIBOR in relation to many financial products, any potential cessation of publication could have a financial and operational impact. It is therefore important that market participants seek to understand how this may affect them. This may be achieved by taking some initial steps, including (though not necessarily limited to):

    • Identify which products they use that reference LIBOR;
    • Identify what amount of exposure these products have to LIBOR, including which mature after the end of 2021;
    • Examine and, if necessary, amend existing products to ensure there is robust language in place that sets out the steps to be taken, or the interest rate to be applied, in case LIBOR is no longer available (note the process for amending a particular financial product will depend on its terms and may require a consent process);
    • Ensure appropriate documentation is in place to adequately disclose or mitigate risks associated with the discontinuation of LIBOR;
    • For new products, explore how to use RFRs or other alternatives to LIBOR; if continuing to reference LIBOR, determine if there is robust language in place that sets out the steps to be taken, or the interest rate to be applied, in case LIBOR is no longer available;
    • Produce an inventory of relevant systems used (e.g. trade booking, risk systems) that may be affected should LIBOR no longer be published in the future, and consider making changes that will allow those systems to use alternative rates.

    We encourage Market Participants to stay up-to-date on the latest developments and to consider how these changes may impact their organisation and the products in which they transact, using independent professional advisors (legal, accounting, financial, tax or other) as appropriate.

    Market participants are also encouraged to participate in industry consultations and engage with the regulators and other stakeholders in the various RFR working groups to express their views and to better understand the expectations of the regulatory community, particular challenges and any recommended next steps.

    This is not intended to be an exhaustive list but instead, some initial steps market participants may want to consider as a starting point. Further information is available from the PRA/ FCA’s feedback to their Dear CEO letter sent to supervised entities in September 2018, which asked for details of preparations and plans for transition from LIBOR to RFRs.  

  • Risks to consider

    The path to transition away from LIBOR is complex. The alternative rates are calculated on a different basis to LIBOR. The various jurisdictions are at different stages of transition, and are moving at different speeds towards, in all likelihood, different outcomes. It is difficult to imagine a ‘one size fits all’ approach or solution.

    Transition will affect both new and existing products referencing these key interest rate benchmarks, and in different ways. The consequences of reform are unpredictable and may have an adverse impact on any financial instruments linked to, or referencing, any of these benchmarks.

    The transition itself may have potential risks associated with it;

    • Changes to contractual documentation,
    • Adaption of new and/or amended operational processes,
    • Changes to the value of products or the possibility of products no longer serving the purposes for which they were intended.

    Market participants are encouraged to evaluate their individual circumstances and review their LIBOR-linked exposures. Participants should also develop a sufficient understanding of any expected and potential changes as a result of LIBOR transition and how these changes may impact their organisation, using independent professional advisors (legal, accounting, financial, tax or other) as appropriate.

Latest official sector statements on the timelines for LIBOR transition

Working Group on Sterling Risk-Free Reference Rates (RFRWG)

On 25 March 2020, the BoE and FCA published a statement on the impact of coronavirus on firms’ LIBOR transition plans. The central assumption that firms could not rely on LIBOR being published after the end of 2021 remained unchanged, but the impact of coronavirus on the transition plans of many firms, in particular in the loans market, was acknowledged.  They released a further statement on 29 April 2020, providing a further assessment of the impact of coronavirus on the sterling LIBOR linked loans market, with regard to transition.

On 28 July 2020, the RFRWG issued a further statement, informing market participants of the additional materials they have produced to assist firms in progressing their LIBOR transition plans. Tushar Morzaria, Barclays Group Finance Director and Chair of the RFRWG said “Transition from LIBOR in sterling markets continues at pace. Today’s publications are designed to further support firms that have transition plans in place as well as corporates and end-users, for whom focus on transition is also crucial this year. I am encouraged by the continued progress and efforts in sterling markets and look forward to the RFRWG continuing to provide leadership in the sterling market transition from LIBOR by end 2021”. The RFRWG’s top level priorities for 2020-21are:

  1. By end-Q1 2021, lenders and borrowers take necessary steps to cease issuance of LIBOR linked loan products that expire after the end of 2021, including by end-Q3 2020 making non-LIBOR alternatives available and including contractual conversion mechanisms in new or refinanced LIBOR products
  2. Take steps throughout 2020 to promote & enable widespread use of SONIA compounded in arrears
  3. Take steps to enable a further shift of volumes from GBP LIBOR to SONIA in derivative markets
  4. Establish a clear framework to manage transition of legacy LIBOR products, to accelerate reduction of stock of GBP LIBOR referencing contracts by end-Q1 2021 and complete active conversion where viable by end-Q2/Q3 2021
  5. Provide market input on issues around “tough legacy”

The RFRWG roadmap also details the key latest milestones in the lead up to the end of 2021.

Alternative Reference Rates Committee (ARRC)

In its most recent FAQs on benchmark rate reform, the ARRC has expressed its view (see question 17) on how coronavirus will influence the end-2021expiration date for LIBOR.

The ARRC recognises that “near-term, interim steps may be delayed given the current economic environment”, however it continues “to focus on the established timeline for the transition from LIBOR” and is advancing its work towards the end-2021cessation of LIBOR, in line with its objectives for 2020. The ARRC has also published a set of recommended best practices to prepare for the cessation of USD LIBOR by the end of 2021. These recommendations include proposed target dates for the incorporation of fallback reference rates, operational readiness, and the cessation of USD LIBOR products, while recognising differences between markets:

Product

Hardwired Fallbacks

Incorporated By

Tech/Ops Vendor

Readiness By

Target for Cessation Of New Use Of USD LIBOR By

Anticipated Fallback Rates to be Identified By

Floating Rate Notes

6/30/2020

6/30/2020

12/31/2020

6 month's prior to reset after LIBOR's end

Business Loans

9/30/2020

9/30/2020

6/30/2021

6 month's prior to reset after LIBOR's end

Consumer Loans

Student Loans - 9/30/2020
Mortgages - 6/30/2020

Mortgages - 6/30/2020

Mortgages - 6/30/2020

In accordance with relevant consumer regulations

Securitizations

6/30/2020

12/31/2020

CLOs: 9/30/2021
Other: 6/30/2021

6 month's prior to reset after LIBOR's end

Derivatives

No later than 4 months after the Amendments to ISDA 2006 Definitions are published

Dealers to take steps to provide liquid SOFR derivatives markets to clients

6/30/2021

 

Frequently asked questions (FAQs)

These FAQs explore the background to this journey and discuss the new rates in greater detail.

Disclaimer

This information:

(i) Has been prepared by Barclays Bank PLC and its affiliates (“Barclays”) and is provided for information purposes only and is subject to change. It is indicative only and not binding. 

(ii) Is not research nor a product of the Barclays Research department. Any views expressed in this communication may differ from those of the Barclays Research department. All opinions and estimates are given as of the date of this communication and are subject to change. Barclays is not obliged to inform recipients of this communication of any change to such opinions or estimates.

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