LIBOR to RFR Transition

Welcome to our March 2021 issue of the Risk-Free Rates (RFR) Regulatory Round-up - LIBOR. The beginning of March saw the important official LIBOR cessation announcement from the FCA, which signifies the beginning of the end of LIBOR. Although this announcement was expected, we summarise the likely events and timetable going forward and highlight other updates from across the main markets.

On 3 March the FCA confirmed (PDF 102 KB) the following:

• Cessation on 31 December 2021 of the following LIBOR settings: all Euro; all Swiss franc; Japanese yen - spot next, 1 week, 2 month and 12 month; Sterling - overnight, 1 week, 2 month, 12 month; and US dollar - 1 week, 2 month
• Cessation on 30 June 2023 of US dollar - overnight and 12 month
• On sterling 1 month, 3 month and 6 month settings, it will consult on requiring the LIBOR administrator (IBA) to publish for a further, undefined, period on a changed `synthetic' methodology 
• On Japanese yen 1 month, 3 month and 6 month settings, it will consult on requiring IBA to publish for a further year on a changed `synthetic' methodology 
• For remaining US dollar LIBOR settings, it will continue to consider the case for using its proposed powers, taking into account views and evidence from US authorities.

As a result of the FCA announcement, ISDA confirmed that the `spread adjustments' to be used in the ISDA IBOR fallbacks were fixed on 3 March and that the fallbacks will automatically occur for all outstanding derivatives LIBOR contracts adhering to the ISDA IBOR fallbacks protocol after 31 December 2021 for euro, sterling, Swiss franc and yen, and for US dollar on 30 June 2023. Bloomberg then announced the technical fixing of the spread adjustment.

The FCA published two statement of polices on 3 March, which explain further the next steps it will take in requiring the publication of a synthetic LIBOR.

Permitted use of synthetic LIBOR

The first statement of policy describes how the FCA will designate a benchmark unrepresentative using new powers under a proposed Article 23A in the UK Benchmarks Regulation (UK BMR). This designation would result in a general prohibition on the use of the benchmark, i.e. LIBOR, by supervised entities. However, it also gives the FCA power to exempt some or all existing use of the benchmark from this general prohibition, i.e. tough legacy cases. 

So, it is not yet clear for firms which type of contracts will actually be able to use the synthetic LIBOR sterling, yen and US dollar tenors. The FCA will need to strike a careful balance between incentivising active transition away from LIBOR and managing the disruption that could come from frustrated contracts. The `tough legacy issues' paper produced by the RFRWG gives some indications of the path the FCA could follow.

If the FCA decides to designate a critical benchmark as an Article 23 A benchmark, it will publish a notice in line with the requirements of the proposed Article 23A (10) (b). The proposed amendments to UK BMR under the Financial Services Bill have not yet been approved by Parliament, so this notice has not yet been published for LIBOR.

Likely methodology of synthetic LIBOR

The second statement (PDF 188 KB) of policy sets out how, given the designation of a benchmark under Article 23A (e.g. unrepresentative and generally prohibited not to be used), the FCA can impose requirements on a benchmark administrator under proposed Article 23D(2). These include the way the benchmark is determined and the rules of the benchmark. The statement of policy sets out the factors the FCA will take into account, and whether and how it will use these powers. 

The FCA will consult in Q2 2021 about how to use these powers in respect of certain LIBOR currency tenor settings. However, it has made clear in a prior consultation (PDF 272 KB) the methodology that it is likely to require for synthetic LIBOR - a forward-looking term rate version of the relevant risk free rate plus a fixed spread adjustment calculated over the same period and in the same way as the spread adjustment in ISDA IBOR fallbacks. 

With all these announcements, firms will now be able to identify a population of contracts which they will have either actively to transition away from LIBOR or to ensure they have robust fallbacks from LIBOR - specifically, euro, Swiss franc, some yen and sterling contracts. However, for the remaining yen and sterling contracts, it is not yet clear the type of contracts that will be able to use synthetic LIBOR and the economic consequences of using synthetic LIBOR.

In the sterling markets, the next key milestone is the ceasing of new issue of GBP LIBOR-linked loans by the end of March 2021. The Working Group on Sterling Risk-Free Reference Rates (RFRWG) continues to publish useful information for the firms to help them with transition. This includes a Q&A document relating to this milestone. The RFRWG has also consolidated all previous publications to produce a single Best Practice Guide for GBP loans maturing after end of 2021.

From 15 April, the ECB will publish compounded euro short-term rate (€STR) average rates. Publication will include tenors of 1 week, 1 month, 3 months, 6 months and 12 months, as well as a compounded €STR index enabling the derivation of compounded rates for any non-standard tenor. The rules (PDF 121 KB) for the calculation and publication take into account the outcome of the public consultation on the design of the rates and index.

On 8 March, the US Alternative Reference Rates Committee (ARRC) confirmed (PDF 135 KB) that the announcements by the FCA constituted a `Benchmark Transition Event' with respect to all USD LIBOR settings pursuant to the ARRC recommendations regarding more robust fallback language for new issuances or originations of LIBOR floating rate notes, securitizations, syndicated business loans and bilateral business loans.

The ARRC is hosting a series of webinars on transitioning away from LIBOR - The SOFR Symposium: The Final Year.

The ARRC also announced (PDF 173 KB) that it has selected Refintiv to publish ARRC-recommended spread adjustments to SOFR-based rates and spread-adjusted SOFR-based rates for cash products that transition away from US dollar LIBOR. Refinitiv will make the spreads and spread-adjusted rates readily accessible on a daily basis to the general public without cost.

The Federal Reserve Bank continued to emphasise the need for firms to actively manage the transition away from LIBOR by issuing guidance on the six factors on which firms plans' should be assessed: (1) transition planning; (2) financial exposure measurement and risk assessment; (3) operational preparedness and controls; (4) legal contract preparedness; (5) communication; and (6) oversight. The guidance emphasised that examiners should consider issuing supervisory findings and other supervisory actions if a firm is not ready to stop issuing LIBOR-based contracts by 31 December 2021.