LIBOR Cessation and Non-Representativeness Announcement Notice

On 4 December 2020, following discussions with the UK Financial Conduct Authority (FCA) and other official sector bodies, the ICE Benchmark Administration (IBA), the administrator of LIBOR, published a consultation on its intention to cease publication of LIBOR settings either on 31 December 2021 or 30 June 2023, depending on the LIBOR setting. The IBA consulted on these intended cessation dates because a majority of LIBOR panel banks had communicated to the IBA that they would not be willing to continue contributing to the relevant LIBOR settings after such dates. As a result, the IBA considered that it would be unable to publish the relevant LIBOR settings on a representative basis after such dates.

On 5 March 2021, the IBA published a feedback statement on its consultation on potential cessation of LIBOR. In that feedback statement, the IBA stated that it shared and discussed the feedback from the consultation with the FCA. In the absence of sufficient panel bank support, and without the intervention of the FCA to compel continued panel bank contributions to LIBOR, the IBA stated that it is not possible for the IBA to publish the relevant LIBOR settings on a representative basis beyond the intended cessation dates for such settings.

As a result of the IBA not having access to input data necessary to calculate LIBOR settings on a representative basis beyond the intended cessation dates set forth in the table below, the IBA stated that it has to cease publication of the following LIBOR settings immediately after the publication of LIBOR on the below dates unless the FCA exercises its proposed new powers which are included in the current Financial Services Bill as proposed amendments to the UK Benchmarks Regulation (BMR) to require the IBA to continue publishing these LIBOR settings using a changed methodology (also known as a “synthetic” basis).

LIBOR Currency
LIBOR Settings
Date
USD
1-week, 2-month
31 December 2021
USD
All other settings (i.e., Overnight, 1-month, 3-month, 6-month and 12-month)
30 June 2023
GBP, EUR, CHF, JPY
All settings
31 December 2021

LIBOR Cessation and Non-Representativeness Announcement Notice (continued)

The IBA also stated that the FCA had advised the IBA that it has no intention of using its proposed new powers to require the IBA to continue the publication of any EUR or CHF LIBOR settings, or the Overnight/Spot Next, 1 Week, 2 Month and 12 Month LIBOR settings in any other currency, beyond the above intended cessation dates for such settings. The IBA’s statement also said the FCA will consult on using these proposed new powers to require the IBA to continue the publication on a “synthetic” basis of the 1 Month, 3 Month and 6 Month GBP and JPY LIBOR settings beyond such dates, and will continue to consider the case for using these proposed powers in respect of the 1 Month, 3 Month and 6 Month USD LIBOR settings.

This was confirmed by a public announcement by the FCA on 5 March 2021, which also stated that where the FCA decides to require the IBA to continue the publication of any settings on a synthetic basis, LIBOR settings published on this synthetic basis will no longer be representative of the underlying market and economic reality the setting is intended to measure as those terms are used in the BMR. 

The FCA further confirmed that it follows that all 35 LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after the dates set out above.

The IBA’s public statement is available here.

The FCA’s public statement is available here.

We encourage you to do your own due diligence regarding your LIBOR exposure and to ensure that any additional LIBOR exposure is carefully justified. You should consider areas in your business that are impacted, including systems, documentation, risk management and accounting. Even if you have no balance sheet exposure to LIBOR, you may still be exposed to other risks in connection with LIBOR cessation or LIBOR becoming non-representative, including operational, legal and financial challenges. For example, you may need to change your pricing and valuation systems if a LIBOR rate is a key input.

Additionally we encourage you to seek independent advice regarding any legal, commercial or regulatory implications which LIBOR cessation or LIBOR becoming non-representative may have on your financial arrangements or which may arise through implementing different transition options, including but not limited to, derivatives transaction reporting rules, margining and collateral requirements or clearing obligations. Please also refer to your relevant authorities and independent advisors in relation to any accounting and tax implications of transition. These requirements may apply to you and us differently in different jurisdictions.

Additionally, if you plan to enter into any new LIBOR-referencing derivatives transactions maturing past 31 December 2021, please read the important disclosure here.

As nothing in this document should be taken to be advice, we encourage you to seek independent advice on these matters and you should reach your own conclusions and decisions, in consultation with your own advisors.

The information in this document might change and we are not undertaking to update it.

Transition considerations

There are a range of matters which could be relevant to you in relation to LIBOR transition. These matters will depend on your circumstances, including your portfolio of existing transactions and their contractual terms. For example, the implications for you of the cessation of LIBOR or it becoming non-representative may be unclear if your contractual terms do not currently adequately address these circumstances. To manage this lack of clarity, some of the matters which you may wish to consider include:

  • Adhering to a contractual fall-back solution adopted industry-wide (such as the ISDA Protocol for derivatives transactions) or entering into a bilateral amendment agreement;
  • Restructuring your portfolio to reference RFRs instead of LIBOR;
  • Relying on the fall-backs or other provisions within your existing documentation, if suitable; or
  • A combination of these and other actions.

Some industry bodies have developed contractual clauses (‘fallbacks’) which can be incorporated into new and existing contracts that reference LIBOR or another key IBOR. Those fallbacks are intended to address the discontinuance of LIBOR or any of those IBORs by referencing a specified RFR as an alternative rate in the event LIBOR or any of those IBORs are discontinued permanently or LIBOR is determined to be ‘non-representative’. There may be some differences to the fallbacks across asset classes. Therefore, a mismatch in replacement rates and interest calculations across products in your portfolio may arise. It is important to be aware of the applicable fallbacks across your contractual exposures in order to make informed transition decisions.

When amending contracts to transition from LIBOR to RFRs, or other alternative rates, the possibility of value transfer needs to be considered. This is because of the economic differences between LIBOR and RFRs, which result from, amongst other factors, the term credit risk premium that is built into LIBOR, but not into RFRs.

We recommend that your transition plans take account of the time required to amend your documentation. 

We encourage you to do your own due diligence regarding your LIBOR exposure and to ensure that any additional LIBOR exposure is carefully justified. You should consider areas in your business that are impacted, including systems, documentation, risk management and accounting. Even if you have no balance sheet exposure to LIBOR, you may still be exposed to other risks in connection with LIBOR cessation or LIBOR becoming non-representative including operational, legal and financial challenges. For example, you may need to change your pricing and valuation systems if a LIBOR rate is a key input.

Additionally we encourage you to seek independent advice regarding any legal, commercial or regulatory implications which LIBOR cessation or LIBOR becoming non-representative may have on your financial arrangements or which may arise through implementing different transition options, including but not limited to, derivatives transaction reporting rules, margining and collateral requirements or clearing obligations. Please also refer to your relevant authorities and independent advisors in relation to any accounting and tax implications of transition. These requirements may apply to you and us differently in different jurisdictions.

Additionally, if you plan to enter into any new LIBOR-referencing derivatives transactions maturing past 31 December 2021, please read the important disclosure here.

As nothing in this document should be taken to be advice, we encourage you to seek independent advice on these matters and you should reach your own conclusions and decisions, in consultation with your own advisors.

The information in this document might change and we are not undertaking to update it.

Publications and developments in loan markets

Various working groups and industry groups have been developing recommendations for conventions to be used in RFR-referencing loan documentation. These include documentation materials incorporating:

  • Recommendations for RFR facilities agreements
  • Recommendations for RFR multi-currency facilities agreements 
  • Recommendations for facilities incorporating rate switch provisions
  • Recommendations for multi-currency compounded rate/term facilities agreements.

We refer to the publications of respective industry associations including the LMA, APLMA, and the LSTA.

Developing conventions in loan markets, particularly those relating to the calculation of RFR coupons, may vary across jurisdictions. Standards may also be different from those in the derivatives market. ISDA is working on new 'rate options' to be used in derivatives documentation. This could facilitate the use of RFRs in hedging derivatives using conventions which are being developed in the loan markets.

For some practical considerations regarding the amendment of existing loan contracts which reference a LIBOR rate, the Sterling Working Group has published:

When amending contracts to transition from LIBOR to RFRs, or other alternative rates, the possibility of value transfer needs to be considered. This is because of the economic differences between LIBOR and RFRs, which result from, amongst other factors, the term credit risk premium that is built into LIBOR, but not into RFRs.

The Sterling Working Group has stated: “When amending loan contracts to actively transition from GBP LIBOR to SONIA or other alternative rates – whether directly, by way of pre-agreed conversion terms or through an agreed process for renegotiation – the possibility of value transfer needs to be carefully considered. This is because of the economic differences between GBP LIBOR and SONIA, which result from, amongst other factors, the term credit risk premium that is built into GBP LIBOR, but not into SONIA. The concept of a credit adjustment spread ("CAS") has been used in the market as a way to mitigate, as far as possible, any value transfer”.

In December 2020, the Sterling Working Group published a paper “designed to support loan market participants in considering credit adjustment spreads for active transition” from LIBOR to RFRs. The paper does not recommend a particular approach in respect of active transition, stating that it is “for parties to agree”. However, “based on loan transactions executed to date and approaches taken in the bond and derivatives markets, two key methodologies of calculating the CAS have emerged”:

a)      The five-year historical median approach; and

b)     The forward approach (based on the forward-looking swap market).

The first method is based on a historical difference between LIBOR and an RFR. The second is often used in the derivatives market and bond markets. In respect of the second method, the Sterling Working Group explained: “It should be noted that the forward and historical curves are expected to undergo some degree of convergence as the end of 2021 ……..approaches”.

One of the stated priorities of the Sterling Working Group is that by the end of March 2021, new GBP LIBOR-linked loans that expire after the end of 2021 are no longer initiated. Working groups in some other jurisdictions have published similar milestones, taking effect at different times. As a result of these announcements we may no longer be offering new LIBOR-referencing loans ahead of LIBOR’s cessation or becoming non-representative.

Publications and developments in derivatives markets

Activity in the RFR derivatives market continues to increase steadily, particularly in the sterling market. Recent data suggests that a little more than 10% of all derivatives risk is now traded referencing an RFR. In the sterling market transition has progressed the furthest: close to 45% of risk-weighted activity is now referencing SONIA.

One of the stated priorities of the Sterling Working Group is that by the end of March 2021, new GBP LIBOR-linked linear derivatives that expire after the end of 2021, are no longer initiated, except for risk management of existing positions.

The Sterling Working Group has stated that it intends to work with the FCA to explore the potential to change market standard trading conventions to a SONIA basis in non-linear derivatives market and the exchange traded derivatives market at an appropriate point during the second quarter of 2021.  Working groups in some other jurisdictions have published similar milestones, taking effect at different times.

As a result of these milestones, your ability to transact in LIBOR-referencing derivatives may be adversely affected prior to LIBOR’s cessation or becoming non-representative.

ISDA has amended certain ‘floating rate options’ in the 2006 ISDA Definitions to include fallbacks that would apply upon the permanent discontinuation of certain key IBORs and upon a ‘non-representative’ determination for LIBOR. ISDA also amended certain floating rate options that use USD LIBOR as an input to include fallbacks that would apply if USD LIBOR is permanently discontinued or upon a ‘non-representative’ determination for USD LIBOR. Transactions incorporating the 2006 ISDA Definitions that are entered into on or after 25 January 2021 include the amended floating rate option (i.e., the floating rate option with the applicable fallback). Transactions entered into prior to 25 January 2021 (so called “legacy derivative contracts”) continue to be based on the 2006 ISDA Definitions as they existed before they were amended pursuant to the ISDA Supplement, and therefore will not include the amended floating rate option with the ISDA Supplement’s applicable fallback unless they are separately amended (e.g. by bilateral agreement or the ISDA Protocol described below).

ISDA has published the ISDA Protocol to facilitate multilateral amendments to include the amended floating rate options, and therefore the fallbacks, in legacy derivative contracts which are covered by the ISDA Protocol.  Such contracts include ISDA master agreements, ISDA credit support documents, certain confirmations of transactions forming part of an ISDA master agreement, and a range of non-ISDA documentation and confirmations of transactions forming part of such non-ISDA documentation, each of which are listed in the ISDA Protocol.

By adhering to the ISDA Protocol, market participants agree that their legacy derivative contracts which are covered by the ISDA Protocol with other adherents include the amended floating rate option for the relevant IBOR and therefore include the applicable fallback. As always, the ISDA Protocol is completely voluntary and amends contracts only between two adhering parties (i.e., it does not amend contracts between an adhering party and a non-adhering party or between two non-adhering parties). The fallbacks included in legacy derivative contracts that incorporate the 2006 ISDA Definitions by adherence to the ISDA Protocol are equivalent to the fallbacks included in new transactions that incorporate the 2006 ISDA Definitions and that are entered into on or after 25 January 2021.  While both the ISDA Supplement and the ISDA Protocol cover various LIBORs and key IBORs, there are some IBOR rates for which they do not give fallbacks. ISDA has published FAQs relevant to the ISDA Protocol and further information can be found on the ISDA website

A list of adherents to the ISDA Protocol which includes CommBank can be viewed here. You are encouraged to undertake your own due diligence in relation to the ISDA Protocol and the amendments to the 2006 ISDA Definitions and we encourage you to seek independent advice.

The 5 March 2021 statement by the FCA has consequences for the derivatives fallbacks under the ISDA Supplement. On 5 March 2021 the FCA also explained that “as ISDA has confirmed separately, the ‘spread adjustments’ to be used in its IBOR fallbacks will be fixed today as a result of the FCA’s announcement, providing clarity on the future terms of the many derivative contracts which now incorporate these fallbacks.” 

Things you should know

As nothing in this document should be taken to be advice, we encourage you to seek independent advice on these matters and you should reach your own conclusions and decisions, in consultation with your own advisors. The information in this document might change and we are not undertaking to update it.

This information is published solely for information purposes. It is not to be construed as a solicitation, an offer or recommendation by the Commonwealth Bank of Australia (CommBank). As this information has been prepared without considering your objectives, financial situation or needs, you should before acting on the information, consider its appropriateness to your circumstances. It must not be relied upon as investment research. CommBank believes that the information is correct and any opinions, conclusions or recommendations are reasonably held or made, based on the information available at the time of its compilation, but no representation or warranty, either expressed or implied, is made or provided as to accuracy, reliability or completeness of any statement made. Commonwealth Bank of Australia ABN 48 123 123 124. AFSL and Australian Credit Licence 234945.