LIBOR Transition

Post-GFC changes in patterns of major bank funding resulted in the wholesale interbank loans supporting LIBOR to decline significantly in liquidity and turnover. LIBOR panel bank submissions were thus becoming increasingly reliant on dealer judgment, not actual transactions.

Major global regulators recognised that vulnerabilities could lead to benchmark manipulation and considered the implications for financial stability. In July 2013, IOSCO published their Principles for Financial Benchmarks with the aim of creating an overarching framework for benchmarks used in financial markets.

As a result of these recommendations, many IBORs around the world underwent, or are undergoing reforms, including all of the various LIBOR rates.

On 5 March 2021, the UK’s Financial Conduct Authority (FCA) confirmed that all London Interbank Offered Rate (LIBOR) settings would no longer be representative and consequently, cease to be provided by any administrator:

• immediately after 31 December 2021, in the case of all GBP, EUR, CHF, and JPY settings, and 1-week and 2-month US Dollar settings; and
• immediately after 30 June 2023, in the case of all remaining USD settings.

USD LIBOR will no longer be published after 30 June 2023. An alternative rate setting benchmark is required for loans that do not already have fallback language that provides a replacement mechanism for LIBOR in the loan agreement.

Cessation guidance is being provided by the Alternate Reference Rate Committee, (ARRC) of the US Federal Reserve system. The ARRC is a US-based industry body which provides guidance and recommendations for replacing USD LIBOR.

Once USD-LIBOR publication ceases, contracts that reference LIBOR may not function as the parties originally intended.

Consequently, regulators have worked with industry to develop Alternate Reference Rates (ARRs) and have encouraged the parties to USD LIBOR deals to transition these deals to them.

For USD deals transition guidelines and recommendations have been developed by the ARRC to assist parties as they transition to the ARRs.

For USD markets the USD SOFR (Secured Overnight Finance Rate) forms the basis of ARRC endorsed alternatives for USD LIBOR. 

In the US, ARRC has endorsed SOFR which can be used in different interest formats. Some of these formats are described at the following links:

• CME Term SOFR
• Compound SOFR
• ARRC Comparison

Where different formats using SOFR are compared to corresponding USD LIBOR rates there may be differences in the outcomes.

Participants should conduct their own evaluations and seek independent advice if necessary.

In the example of a 6-month resetting USD-LIBOR instrument with reset dates of 15^th March 2023, and 15^th September 2023, the transaction would transition after 30 June 2023 via a fallback to SOFR:

• USD LIBOR would be used in the normal manner in calculation of interest obligations for the March-to-September interest period; and
• SOFR plus a Credit Adjustment Spread (CAS) would then be used in all subsequent interest periods.

Fallback language refers to terms in documentation that provide for a transition to SOFR in the event that USD LIBOR publication is disrupted or discontinued as will happen after 30 June 2023.

If suitable fallback language is not included in contracts, the ongoing viability of that contract may be impacted once USD LIBOR ceases to be published.

It is common for facility agreements to contain clauses related to technical, administrative, and operational aspects of the facility.

Where such clauses have an existing reliance upon the USD LIBOR rate, these will need to be considered alongside the transition of the floating reference rate, and possibly amended. For example, the inclusion of a credit adjustment spread.

USD LIBOR and SOFR are based on distinctly different economic bases.

For example, USD LIBOR contains credit and liquidity sensitivity to wholesale banking sector funding rates relevant at a particular time to a LIBOR tenor (e.g., 3-month)

By comparison, SOFR rates are very nearly free of credit sensitivity given the underlying instruments used in their calculation and their overnight tenor which significantly reduces the credit and liquidity impacts.

Given these differences, industry and national working groups recommend the use of a credit adjustment spread, or CAS, where legacy USD LIBOR deals transition to SOFR to accommodate for the differences in credit and liquidity between them.

For further information on the formation and official sector recommended use of CAS, please see:

ARRC recommendations

ARRC_Recommendation_Spread_Adjustments_Cash_Products_Press_Release.pdf (newyorkfed.org)

FSB

FSB OSSG Supports Use of the ISDA Spread Adjustments in Cash Products

ISDA

ISDA Publishes Results of Consultation on Final Parameters for Benchmark Fallback Adjustments – International Swaps and Derivatives Association

Yes, by definition, where the application of CAS is not applied uniformly an economic difference will likely arise in the performance of cash and derivative products, with a range of potential consequences.

For this reason, industry and national working groups have strongly advocated consistency of CAS across cash products and related derivatives.

Export Finance Australia does not provide legal, tax, financial or accounting advice.

Counterparts are encouraged to consider any facility amendments and the appropriateness of transition arrangements incorporated therein together with their legal, tax, financial and accounting advisers, taking into consideration their particular circumstances.

Export Finance Australia does not provide legal, tax, financial or accounting advice.

It is important for clients to understand the financial and operational impact of LIBOR transition, and as soon as possible commence determining:

• which products and services reference USD LIBOR;
• whether the relevant contracts have rate sets after 30 June 2023;
• whether documentation includes any terms such as fallback terms that provide adequate risk mitigation;
• the systems and infrastructure that may require updating;
• the accounting and tax consequences of changes to the terms of products or services; and
• the appropriateness of alternative benchmark interest rates, such as the ARRs.

Your Export Finance Australia relationship executive is available to discuss aspects of LIBOR transitions for deals which face Export Finance Australia.