One challenge to preparing for the LIBOR phaseout is selecting the appropriate credit adjustment spread. Understanding the differences between IBORs and RFRs is essential and you’ll need to consider these aspects when adjusting client contracts or when assessing valuation impacts.
In this blog article, we dive further into some of the key differences between today’s Interbank Offered Rates (IBORs) and proposed new Alternative Risk-Free Rates (RFRs). Furthermore, we examine the advantages and disadvantages of the proposed RFRs.
As highlighted in our last blog, RFRs currently have no term structure and some of the proposed alternative RFRs (including SARON) are secured and as a consequence, unlike IBORs, do not bear a credit spread. These aspects will need to be considered when preparing for the transition, such as when adjusting client contracts or when assessing valuation impacts.
To address these issues, the International Swaps and Derivatives Association (ISDA) conducted a survey of 147 entities including banks, asset managers, insurers, pension funds and corporates. Market participants submitted responses on the proposed fallbacks for CHF LIBOR, GBP LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR and BBSW. The ISDA’s findings were published in a final report on 20 December 2018.
Two key takeaways from the report:
- Regarding to credit spread and term structure, a majority of respondents favored the “compounded setting in arrears rate term adjustment” combined with the “historical mean/median spread adjustment approach”.
- ISDA plans to develop fallbacks for inclusion in its standard definitions based on the favored approach.