Changes to LIBOR (and other IBORs)

02/12/2019

LIBOR, the London Interbank Offered Rate, is being retired. It, and most other Interbank Offered Rates (IBORs), are making way for more reliable replacements. Others are being reformed.

What is LIBOR?

LIBOR is an interest rate, or more correctly a family of interest rates, that are representative of the rates at which banks have historically been prepared to lend among themselves. They are available across a range of standardised time horizons, from overnight to 12 months ahead. Each rate is calculated based on quotes, or submissions, from a panel of banks for a number of major currencies.

LIBOR maturities

Overnight2 months
Spot/Next*3 months
1 week6 months
1 month12 months

*an overnight rate from the spot date (usually 1 or 2 days hence) to the next business day

Source: M&G, ICE, September 2019.

Summary

By the end of 2021, new rates will be in place for each IBOR. Financial regulators have been closely engaged with industry working groups to identify alternative replacement reference rates.

In the UK, for example, the Sterling Overnight Index Average, also known as SONIA, has been chosen to replace Sterling LIBOR. In the US, the Secured Overnight Financing Rate, SOFR, will replace US$ LIBOR.

Purpose and timing of the changes

Regulators globally want to promote greater transparency, measurability and credibility in central-bank administered rate-setting processes, which are based on actual transactions, where possible.

They have acted because the use of interbank lending has declined substantially since the global financial crisis, which has had an effect on the reliability of some LIBOR rates. Panel banks are still providing quotes across LIBOR’s broad spectrum of rates, but the volume of transactions has fallen. Historic rate-rigging scandals also continue to weigh on LIBOR’s reputation, despite it now being subject to much stricter official oversight.

The regulators require the replacement rates to be in place by the end of 2021. The transition process is already underway, with most replacement rates already having been identified, and it is possible, or even likely, that the replacement rates will be in full effect before that current deadline.

One reason for providing a long lead time is to give parties affected by the changes sufficient time to ensure as smooth a transition as possible and to minimise the effect on all market participants. Ideally, the changes will be transparent and borrowers, lenders and investors will experience little or no effect.

We aim to provide regular updates to this information to reflect the position of the transitions as they develop.

Current solutions

Industry working groups in each market have already identified preferred replacement risk-free rates (RFRs). The main ones are:

  • UK sterling – Sterling Overnight Index Average (SONIA) replaces £ LIBOR – SONIA has existed for more than 20 years and is used in the sterling overnight indexed swaps market, and now, increasingly, as a reference interest rate for borrowing
  • US dollars – Secured Overnight Financing Rate (SOFR) replaces US$ LIBOR – SOFR will sit alongside, and eventually replace, US$ LIBOR. SOFR is based on transactions in the Treasury repo market and has existed since 2014, though only officially published since April 2018
  • Euro – Euro short-term rate (€STR or ESTR) and Euribor – The European Central Bank announced ESTR as the successor to the Euro overnight index average (EONIA). Currently, European authorities plan to retain a reformed version of Euribor rather than replace it

Timeline

The agreement from panel banks to provide quotes for LIBOR expires on 31 December 2021. Some of the key milestones that have occurred to date in the development of solutions, and the transitions to them are highlighted below:

April 2018 – SONIA is reformed by the Bank of England, though it had been in use since 1997. First official publication of SOFR by the US Federal Reserve Bank of New York.

13 September 2018 – ESTR is recommended as the replacement RFR for EONIA, which will be discontinued from 3 January 2022.

2 October 2019 – ESTR is published for the first time by the ECB, reflecting transactions that took place on 1 October 2019.

Alternative rates

Current Reference Rate Currency Expected Alternative First Publish Dates (as alternatives) Alternative Rate Supervisor Cut off date Status as of October ‘19
LIBOR London Inter-Bank Offered Rate GBP SONIA Sterling Overnight Index Average (Unsecured) 23rd April 2018 Bank of England 31 Dec 2021 New SONIA swap, bond and limited loan issuances with trial bond conversions*
USD LIBOR USD London Inter-Bank Offered Rate USD SOFR Secured Overnight Financing Rate (Secured) 3rd April 2018 Federal Reserve Bank of New York 31 Dec 2021 New SOFR bond and swap issuances**
EURIBOR Euro Inter-Bank Offer Rate EUR EURIBOR Undergoing reform – EU regulator say they are happy with the progress and developments so far Staggered reform to finish by end 2019 European Money Markets Institute N/A Reform underway***
EONIA and EUR LIBOR Euro Overnight Index Average / Euro London Inter-Bank Offered Rate EUR ESTR Euro Short Term Rate (Unsecured) 2nd October 2019 European Central Bank 31 Dec 2021 New FRN and derivative issuances***
CHF LIBOR CHF London Inter-Bank Offer Rate CHF SARON Swiss Average Rate Overnight (Secured) December 2017 SIX Swiss Exchange Ltd 31 Dec 2021 New SARON bond and swap issuances
JPY LIBOR and TIBOR JPY London Inter-Bank Offered Rate / Tokyo Interbank Offered Rate (TIBOR) (derivatives only) JPY TONA Tokyo Overnight Average Rate (Unsecured) / TIBOR December 2016 Bank of Japan 31 Dec 2021 Limited swaps trading
BBSW Bank Bill Swap Rate AUD AONIA Interbank Overnight Cash Rate (Unsecured) 27th May 2019 Reserve Bank of Australia AONIA to Compliment Reformed BBSW AONIA may replace 1-month BBSW, but other tenors expected to remain
NIBOR Norwegian Interbank Offered Rate NOK NOWA Norwegian Overnight Weighted Norwegian Overnight Weighted Average (Unsecured) 1st Jan 2020 Norges Bank 31 Dec 2021 Awaiting alternative rate takeover by central bank
WIBOR Warsaw Interbank Offered Rate PLN WIBOR Reformed WIBOR TBD GPW Benchmark SA N/A Reform underway
Note: CDOR (Canadian IBOR), HIBOR (Hong Kong IBOR), SIBOR (Singapore IBOR) and other currencies not included as no IBOR exposure found.
*Refer to Sterling Markets: GBP LIBOR to SONIA, **Refer to US Dollar Markets: USD LIBOR to SOFR, ***Refer to Euro Markets: Reformed EURIBOR and EONIA to ESTR

Some Frequently Asked Questions

How might it affect my client's investments?

We are members of the industry group, supported by the Financial Conduct Authority (FCA) and the Bank of England, working to make the market-wide transition as smooth as possible, and determining best practice in areas of the market, such as floating rate notes. Any effect on the value of your clients investments is currently expected to be negligible or very small, at the time of change. However, there can be no guarantee that circumstances may not arise which result in a more material change to investment values.

Where a fund has an objective related to LIBOR it will need to change. We will make this change in line with best market practice and with the aim to have minimal effect on how the fund is managed. We will communicate to you and your clients any planned changes to fund objectives before they take effect.

How do the new rates differ from the IBORs they are replacing?

The replacement rates are largely similar to the IBORs they are replacing, but there are some important differences industry participants should be aware of.

  • Quote-based versus Transactions-based – IBORs have historically been calculated based on quotes provided by a panel of banks (different for each currency). The replacement RFRs will use a transaction-based approach.
  • Term rates versus Overnight rates - IBOR rates are forward-looking interest rates for specific time periods, or terms. The replacement RFRs are backward-looking rates, published based on transactions that occurred on the previous day. Therefore, new mechanisms will be required to determine how much interest will be payable on a bond or loan that uses the new rates.

    This difference is one of the main challenges facing the industry. For example, a great deal of consultation and work is currently underway to resolve this issue and create “term SONIA” rates.
  • Unsecured vs Secured
    IBOR rates are unsecured, which is common practice in the markets. While some of the replacement RFRs are unsecured, some are secured against particular assets. Secured borrowing rates are typically lower than unsecured rates.

    Unsecured lending is provided “in good faith”, with no collateral provided by the borrower to protect the lender. Secured lending means that the borrower provides something of value – collateral – to support its borrowing.

Do I need to take any action?

No. We are managing the transition away from LIBOR and other IBORS in a way that is intended to minimise the effect on all our customers.


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