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.
LIBOR Transition gets real
Barclays is 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 also 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.
We intend to follow milestones set out by the various Risk-Free Rate Working Groups with respect to providing LIBOR-linked products maturing after the end of 2021, and are currently exploring ways to reduce our footprint in relation to LIBOR-linked products.
The ICE Benchmark Administration (IBA), the authorised administrator of LIBOR, has started a consultation on its intention to cease the publication of:
- All tenors of EUR, CHF, JPY and GBP LIBOR settings, to take effect after the publication of LIBOR on 31st December 2021
- 1 week and 2 month tenors of USD LIBOR settings, to take effect after the publication of LIBOR on 31st December 2021
- Overnight and 1, 3, 6 and 12 month tenors of USD LIBOR settings, to take effect after the publication of LIBOR on 30th June 2023
Respondents to the consultation have been requested to provide feedback by 25th January 2021, IBA will then share the results with the FCA and will release a statement summarising responses shortly thereafter. Recent statements from IBA can be found here.
ISDA has noted that these recent statements do not constitute an index cessation event under the IBOR Fallbacks Supplement or the IBOR Fallbacks Protocol and won’t trigger the falbacks contained therein.
The Federal Reserve Board has indicated that they support these statements which would enable a clear end date for USD LIBOR and would promote the safety and soundness of the financial system. The ARRC have also provided a guide about the recent statements for the proposed endgame for USD LIBOR.
A webinar was held by ISDA - The Path Forward for LIBOR on 4th December 2020, in which Edwin Schooling-Latter from the FCA stated:
‘The consultation will cover all five currencies and will close by the end of January. This should make it possible to determine and make announcements on the future path for all five currencies simultaneously, even if the proposed cessation date is different – end-Dec 2021 for four currencies, and end-June 2023 for some US dollar settings. I think everyone’s aim will be to provide clarity to the market on all 35 settings as soon as practicable, in line with the provisions and processes set out in the Benchmarks Regulation and applicable governance procedures. The more time that markets have to prepare, the better’.
On 23rd October 2020, ISDA launched a supplement (the “Supplement”) amending the 2006 ISDA Definitions to include new IBOR fallbacks. The Supplement will come into effect on 25th January 2021 and will be automatically incorporated into any new derivatives transaction which incorporates the 2006 ISDA Definitions entered into on or after 25th January 2021.
The IBOR Protocol was also launched on 23rd October 2020 to enable market participants to incorporate IBOR fallbacks into legacy non-cleared derivatives transactions. The IBOR Protocol will also be effective from 25th January 2021. Market participants who adhere to the IBOR Protocol agree, as between adhering parties, their legacy derivatives (and certain non-derivatives contracts i.e. securities financing transactions, that are within the scope of the IBOR Protocol) will be amended to include the relevant fallbacks.
Whilst the IBOR Protocol will apply to non-cleared derivatives transactions, for legacy cleared derivatives transactions certain CCPs have indicated they will use the powers in their rule books to implement the same fallbacks as of the effective date of the Supplement/IBOR Protocol.
ISDA has produced a factsheet, a FAQ and brochure with further information on IBOR transition. Bloomberg has also published a factsheet, rule book and technical note with further information on the implementation of fallbacks and the calculation of near risk-free rates.
Further information and updates can be found on the ISDA website
We have also drafted our own FAQ document on the Protocol and further information on our adherence.
Barclays has adhered to the IBOR Protocol for its major derivative trading entities (The list of all adhering entities (including Barclays entities) can be found on the ISDA website here)). If you also decide to adhere to the IBOR Protocol, legacy transactions you have with us that are within the scope of the IBOR Protocol will be amended in accordance with the IBOR Protocol. As the IBOR Protocol does not include all benchmarks in its scope, the consequences of discontinuation of any benchmark outside the IBOR Protocol (e.g., CMS, ICE Swap Rate, EONIA) are unpredictable, and your transactions may be adversely impacted. You need to make your own decision as to whether to adhere to the IBOR Protocol based on your individual circumstances, including your IBOR-linked exposures, and assess the potential risks of adhering versus not adhering, in each case either on your own or through independent professional advisors (legal, accounting, financial, tax, or other), as appropriate. This should include evaluation of the changes introduced by the IBOR Protocol including the consequences of a change in interest rate methodology and the impact of the non-representativeness or discontinuation of any IBOR referenced in your transactions. You must satisfy yourself as to the appropriateness or suitability of adhering to the IBOR Protocol and any possible adverse outcome therefrom (including current IBOR transactions ceasing to function as originally intended in respect of certain non-linear products after fallback rates become effective and any potential transfer of economic value). Barclays accepts no responsibility or liability for, and makes no representation or warranty, express or implied, as to, any such risks or consequences. Barclays is not acting as your fiduciary or advisor and is not responsible for assessing the appropriateness or suitability for you of adhering to the IBOR Protocol.
At the end of July, the Working Group on Sterling Risk-Free Reference Rates (RFRWG) issued a 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:
- 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
- Take steps throughout 2020 to promote & enable widespread use of SONIA compounded in arrears
- Take steps to enable a further shift of volumes from GBP LIBOR to SONIA in derivative markets
- 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
- Provide market input on issues around “tough legacy”
In addition, on 28 September 2020, The Bank of England and FCA have published a statement encouraging liquidity providers in the sterling swaps market to adopt new quoting conventions for inter-dealer trading based on SONIA instead of LIBOR from 27 October 2020. The statement is accessible at these locations:
Following the endorsement of this proposal by the Working Group at its 16 September 2020 meeting, this has also been added to its roadmap to help progress transition in the derivatives market:
ARRC Best Practices
In its most recent FAQs on benchmark rate reform, the Alternative Reference Rates Committee (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-2021 cessation 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:
Target for Cessation Of New Use Of USD LIBOR By
Anticipated Fallback Rates to be Identified By
Floating Rate Notes
6 month's prior to reset after LIBOR's end
Syndicated Loans - 9/30/2020
Bilateral Loans – 10/31/2020
6 month's prior to reset after LIBOR's end
Mortgages - 6/30/2020
Student Loans - 9/30/2020
Mortgages - 9/30/2020
Mortgages - 9/30/2020
In accordance with relevant consumer regulations
6 month's prior to reset after LIBOR's end
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
Fallback Language for USD LIBOR Loans
In August 2020, the ARRC also released a statement on the updated Hardwired Fallback Language for Bilateral Business Loans Referencing USD LIBOR. The updated fallback language adjusts the “Hardwired Approach” and the “Hedged Loan Approach” of the final recommended language released in May 2019. The updates are similar to the recent revisions made to the ARRC’s recommended fallback language for new originations of syndicated loans:
- The hardwired approach has been updated to recommend the use of Daily Simple SOFR in the second step of the waterfall
- The ARRC argues that Daily Simple SOFR is already operationalized, reduces operational risk relative to compounded SOFR in arrears, and poses fewer challenges in bilateral loans where intra-period payments are routine
- “A User’s Guide to SOFR” demonstrated that there is little basis between Daily Simple SOFR and compounded SOFR in arrears, thus indicating the rate is still hedgeable with compounded SOFR in arrears hedges
- However, the ARRC recognises that market participants may prefer to align their loans with standard derivatives documentation and thus facilitates modifications to the waterfall
- The hedged loan approach has been updated to include a benchmark rate floor
In order to provide more time for bilateral loans to incorporate these refreshed fallbacks, the ARRC has adjusted its Best Practice recommendations to state that new bilateral loans should incorporate hardwired or hedged fallback language by 31st October 2020 (while the recommended timeline for syndicated loans is still 30th September 2020)
SOFR CCP Switch Over
As part of global industry efforts around benchmark reform and the ARRC’s Paced Transition Plan, key systemic Central Clearing Counterparties (“CCPs”) are expected to switch price alignment interest (“PAI”) and discounting on all cleared USD-denominated derivatives from the Effective Federal Funds Rate (“Fed Funds”) to SOFR on the weekend of 16/17 October 2020. Unlike EONIA/€STR where there was a fixed spread between the two rates, SOFR and Fed Funds are both independent rates without a fixed spread, and as such the CCP switch will result in a change to market participants’ discounting risk which the CCPs will offset by booking Fed Funds/SOFR basis swaps. This is an intended consequence of the paced transition plan, as it is hoped that discount risk hedging needs will increase market activity in SOFR derivatives.
The Euro Overnight Index Average (“EONIA”) became increasingly fragile in recent years due to low volumes and the decline of panel banks members. Consequently, based on the recommendation from the EUR RFR Working Group, the methodology and publication time (e.g. moved to T+1) were changed and since October 2019, EONIA became a tracker rate to the Euro Short-Term Rate (“€STR”), the risk-free rate selected by the EUR RFR Working Group, and is now equal to €STR + a fixed spread of 8.5 bps. €STR will replace EONIA on 3 January 2022 when EONIA is scheduled to be discontinued.
No potential cessation date has been set for EURO Interbank Offered Rate (“EURIBOR”) which 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 EURIBOR is likely to cease anytime soon.
Key CCPs switched PAI and discounting on cleared EUR-denominated IRS products to €STR (from EONIA) on July 25/26 2020. The discounting transition however has not resulted in an increased volume in €STR trading to date as the market continues to use EONIA, causing concern in the official sector given EONIA’s end date is just over a year away.
In Q4 2020, the EUR RFR WG is expected to publish two consultations relating to i) EURIBOR Fallback Triggers and ii) EURIBOR Fallbacks with final recommendations, based on market participants’ responses.
Risks to consider
The path to transition away from LIBOR is complex. The alternative reference rates are calculated on a different basis to LIBOR. Market and industry conventions for alternative reference rates are expected to vary between certain products and markets; these conventions continue to develop and may change over time. Various jurisdictions are at different stages of transition, and are moving at different speeds towards, potentially 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. The consequences of reform are unpredictable and may have an adverse impact on any financial instruments linked to, or referencing, any of these benchmarks.
Counterparties that hold and/or enter into transactions that reference interest rates benchmarks that are subject to reform or cessation may be exposed to potential risks. These risks include, but are not limited to, the following:
- The existing agreements may not fully cater for a scenario where the LIBOR benchmark permanently ceases or is no longer representative, including that the agreement may not have any express fallbacks or have fallbacks that are not effective
- The fallback interest rate calculation provisions of the relevant agreement may become operative, which may impact the expected performance of the transaction or product
- Some changes to contractual documentation may be required. This may include changes relating to the calculation of interest and other payments, which may impact the amount counterparties pay or receive and/or other terms of the relevant agreement that reference LIBOR
- Mismatches (including economic mismatches) may occur if the fallback wording for linked transactions differ: this could be in respect of the underlying reference rate the transactions fall back to and/or the timing of when fall back wording becomes operative. For example, an interest rate swap (hedge) may have different fallbacks to a loan (underlying transaction)
- Methodologies for determining an alternative reference rate and/or calculating a potential credit adjustment spread (which may be necessary for the transition to be as economically neutral as possible) may vary across different types of products and jurisdictions
- It may be necessary to implement new operational processes or systems and/or amend existing ones to support alternative reference rates
- The value of products may change or products may no longer serve the purposes or function as originally intended. For example, as liquidity in LIBOR falls due to to a decrease in the number of LIBOR-referencing underlying transactions, LIBOR and LIBOR-referencing products and transactions may become more volatile
- Alternative reference rates may be materially different from LIBOR interest rate benchmarks which could result in unexpected changes in the performance of the underlying products or transactions
- Barclays may have rights to exercise discretion to determine a replacement rate for interest rate benchmarks linked to a transaction or product
- Interest rate benchmark reform may also result in a variety of tax, accounting and regulatory implications
- Barclays may, in accordance with the relevant rules or methodology of a Barclays index or other quantitative investment strategy, have rights to determine a replacement rate for interest rate benchmarks that feature as a component of such index or strategy and to make any necessary modifications to the methodology as a consequence. The use of a replacement rate and related adjustments may affect the performance of the index or strategy.
- Products linked to or referencing a Barclays proprietary index or strategy in which LIBOR represents a substantive component or signal may be significantly affected if no appropriate substitute benchmarks are available
Market participants are encouraged to evaluate their individual circumstances and review their LIBOR-linked exposures. Except where we otherwise agree with you in writing, Barclays does not provide advice, or recommendations on the suitability of your product choice or financial solution. We encourage all market participants to develop a sufficient understanding of the latest developments in LIBOR reform, any exposure they may have to LIBOR benchmarks, along with any expected and potential changes as a result of LIBOR transition and how these changes may impact them and/or their organisation, using independent professional advisors (legal, accounting, financial, tax or other) as appropriate.
Should you require further information on LIBOR transition, the other areas of the website contain a number of resources including FAQs and useful external links.
Intermediaries and Distributors can click here (PDF 89KB) for information on the impact of RFRs on Floating Rate Note (FRN) coupon interest rate payments.
If you wish to discuss any of the risks associated with LIBOR Transition in more detail, please reach out to your Barclays point of contact.
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.
- Strengthen existing Interbank Offered Rates (IBORs) by underpinning them to the greatest extent possible with transactions data
- 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 , 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.
Frequently asked questions (FAQs)
These FAQs explore the background to this journey and discuss the new rates in greater detail.
Useful External Resources
ISDA: Fallback Consultations
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