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The interest rate benchmark LIBOR is being discontinued. End dates have been announced for all the LIBOR panels.
We expect that you have been discussing the options to transition your contracts away from LIBOR. If you have not done so already, you should finalise your transition away from those LIBORs that are discontinuing after 31 December, without delay.
All LIBOR settings will either cease to be provided by any administrator or no longer be representative:
There are matters to consider that 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.
In what follows, we address some of the most commonly asked questions about transition.
Regulators have stated that, barring some exceptions, market participants should cease entering into new contracts that use USD LIBOR as a reference rate no later than 31 December 2021. This may affect your ability to manage your LIBOR exposures through, for example, trading or hedging.
We highlight that publication of most USD LIBOR tenors was extended to 30 June 2023 primarily to allow a natural run down of legacy USD LIBOR contracts maturing before that extended cessation date. As such, we do not expect to enter into new USD LIBOR contracts with you after 31 December 2021.
To clarify: a ‘new contract’ would include an agreement that creates additional LIBOR exposure for or that extends the term of an existing LIBOR contract. A draw on an existing agreement that is legally enforceable (e.g., a committed credit facility) would not be viewed as a new contract. The aforementioned exceptions are limited to specific types of derivatives trades that support the functioning of financial markets and risk mitigation.
The FCA confirmed that in order to avoid disruption to legacy contracts (which have not transitioned to risk-free rates before year end) that reference the 1-, 3- and 6-month sterling and Japanese yen LIBOR settings it will require the LIBOR benchmark administrator to publish these settings under a synthetic methodology, based on term risk-free rates, for the duration of 2022.
The FCA has said that while synthetic LIBOR reduces risk in the transition and provides a bridge to overnight risk-free rates (RFRs), it will not last indefinitely and contracts need to be moved away from LIBOR wherever possible.
The synthetic rate is intended to provide a reasonable and fair approximation of what panel bank LIBOR might have been in the future (if it wasn’t ceasing). However, the methodology that the FCA will require LIBOR’s administrator to use for calculating these synthetic rates is not based on any panel bank submissions, as LIBOR is presently. Rather, it consists of forward-looking term versions of the relevant risk-free rate plus the respective ISDA fixed spread adjustment (that is published for the purpose of ISDA’s IBOR fallbacks for the 6 LIBOR settings).
Synthetic rates would not be representative of the underlying market and economic reality that LIBOR was intended to measure and would not be for use in cleared derivatives or in new contracts.
RFRs are overnight rates. Therefore an RFR ‘interest rate’ or ‘coupon rate’ will typically be based on an average or a compounding of daily observations of the RFR throughout the interest period. In contrast, LIBOR is a forward-looking rate that provides the ‘interest rate’ or ‘coupon rate’ at the beginning of the interest period.
Since LIBOR rates are based on bank borrowing costs, they may rise in times of financial stress. The low volume of transactions presently underlying LIBOR increases its vulnerability to short-term market illiquidity and amplification of price moves.
Forward looking RFR ‘term rates’ are available in the GBP, USD, and Yen markets but their recommended use may be limited: proposed limitations vary per jurisdiction. For example, term SONIA is not recommended for use in the institutional loan market. We refer to the pages of the respective working groups for additional details.
LIBOR is available in multiple tenors, while RFRs are overnight rates. LIBOR also incorporates a bank credit risk premium and other factors. Adjustments are therefore needed to the RFRs to ensure contracts originally negotiated to reference LIBOR continue to meet the original objectives of the counterparties to the maximum extent possible once the new rate takes effect.
A general market consensus has been established across multiple jurisdictions that a fair way to approximate the expected future difference between LIBOR and RFRs from the point that LIBOR can no longer be published, is to take a historical median of that difference.
For derivatives, the International Swaps and Derivatives Association (ISDA) will use a credit adjustment spread based on the median over a five-year period of the historical differences between LIBOR in the relevant tenor and the relevant RFR compounded over each corresponding period. This method has been endorsed by supervisory bodies for use in other asset classes as well, both for active transition and for use in fallbacks.
That said, the approach to the credit adjustment spread for active transition is for both parties to agree.
We encourage you to seek independent advice regarding any legal, commercial or regulatory implications which LIBOR cessation or LIBOR becoming non-representative may have. Please also refer to your relevant authorities and independent advisors in relation to any accounting and tax implications of transition.
Please contact your Commonwealth Bank representative or the Commonwealth Bank, Interest Rate Benchmark Reform Program directly at IRBR@cba.com.au as soon as practicable.
We encourage you to contact your CommBank representative directly should you require further assistance. For the latest information on LIBOR reform we refer to our ‘LIBOR information Hub’. CommBank is here to help.
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.
