With USD LIBOR due to cease or become permanently unrepresentative after June 2023, Jacob Rank-Broadley explains how the introduction of the LIBOR Act in the U.S. and Refinitiv’s USD IBOR Cash Fallbacks can help smooth the transition.
- The remaining USD LIBOR settings are due to cease or become permanently unrepresentative immediately following 30 June 2023.
- There are trillions of dollars of legacy loans, bonds and securitised products that expire after the end of USD LIBOR and need a replacement benchmark.
- Legislation and the ARRC’s recommended fallback rates can support legacy loans, bonds and securitised products smoothly transition away from USD LIBOR.
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Over the last few years, thanks to an enormous effort by so many, the industry has made huge progress in transitioning away from LIBOR. However, despite this excellent work, there is still one very material hurdle that needs to be overcome before we can call the LIBOR transition a success.
ICE LIBOR® and LIBOR® are registered trade marks of ICE Benchmark Administration Limited (IBA), and are used by Refinitiv with permission under licence by IBA.
Legacy USD LIBOR exposures in cash products
In the March 2021 Progress Report, the Alternative Reference Rates Committee (ARRC) estimated there were around five trillion dollars of legacy USD LIBOR exposures in cash products such as bonds, loans and securitised products that mature when LIBOR is no longer available.
Unlike over-the-counter (OTC) derivatives there isn’t a single protocol that transitions these instruments onto a replacement benchmark.
The industry now has less than a year until 30 June 2023 to select and implement LIBOR fallbacks for trillions of dollars of cash products – this is no small challenge.
Without a one-size-fits-all solution for transitioning cash products away from USD LIBOR, market participants in conjunction with their legal counsel will need to assess the fallback terms of their USD LIBOR contracts.
The most appropriate fallback rate will be determined by a range of factors, including the governing law, whether the contract includes ARRC-recommended fallback language, whether there is a pre-cessation trigger and whether the fallback is selected by the determining person.
Introduction of the LIBOR Act
Fortunately, the recent introduction of the LIBOR Act provides a safety net for contracts under U.S. law that don’t have appropriate fallback language.
For example, there are many bonds and securitisations that fall into this category making it very difficult to change the reference rate due to the need to achieve unanimous consent from the instrument holders.
These types of contracts will move to Fed’s selected replacement after 30 June 2023.
For those contracts under U.S. law that do have appropriate fallback language and a pre-cessation trigger, they will likely move to the ARRC recommended rates.
Recommended fallback rates
In March 2021, the ARRC selected Refinitiv to calculate and publish its recommended fallback rates – USD IBOR Cash Fallbacks.
The rates are based on adjusted SOFR and a spread adjustment, but both the adjusted SOFR and spread adjustment components can differ depending on the convention used.
For example, the spread adjustment for consumer products such as mortgages and student loans has a one-year transition period, while for institutional products, such as corporate loans, bonds and securitised products, it doesn’t.
For many products, the ARRC’s preferred fallbacks are based upon CME Term SOFR, hence Refinitiv recently introduced a forward-looking term rate version of our USD IBOR Cash Fallbacks, which is based upon CME Term SOFR and a spread adjustment.
However, in some circumstances, firms may select an alternative adjusted SOFR. For example, the use of compounded SOFR in arrears may better align with the convention in the derivatives market and aid hedging.
Refinitiv USD IBOR Cash Fallbacks support CME Term SOFR, SOFR compounded in arrears, simple SOFR in arrears and SOFR compounded in advance.
Industry standard agreed rate
USD IBOR Cash Fallbacks are designed to provide market participants, including lenders and borrowers, with an industry standard agreed rate, which can clearly and easily be referenced in contracts.
For example, where a firm elects to use a forward-looking version of USD IBOR Cash Fallbacks, this can likely be a one-for-one switch from USD LIBOR for the equivalent Refinitiv rate without further adjustments. This approach reduces the operational burden associated with the transition.
Once the determining agent has identified the version of USD IBOR Cash Fallbacks that they want to use, market participants need to ensure their systems and processes are updated to support the new benchmark.
This goes far beyond just notifying the relevant counterparties or market participants of the new reference rate as systems for calculating coupon payments and cash flows, valuations, risk systems and reporting all need updating to reflect the new benchmark.
For contracts not under U.S. law, life is somewhat less clear as the preferred fallback likely depends on whether a synthetic USD LIBOR benchmark is created or not. This was recently under consultation by the FCA, so we’ll have to wait and see what happens.
USD ICE LIBOR, which is administered and published by ICE Benchmark Administration Limited (IBA), serves as an input for the Prototype Fallback Rates and/or Fallback Rates. LIBOR®, ICE LIBOR® and ICE Benchmark Administration® are registered trade marks of IBA and/or its affiliates. USD ICE LIBOR , and the registered trade marks LIBOR, ICE LIBOR and ICE Benchmark Administration, are used by Refinitiv with permission under licence by IBA. The Prototype Fallback Rates and/or Fallback Rates are not sponsored, endorsed or provided by IBA or any of IBA’s affiliates. IBA and its affiliates make no claim, predication, warranty or representation whatsoever, express or implied, as to the results to be obtained from any use of LIBOR® or Prototype Fallback Rates and/or Fallback Rates, or the appropriateness or suitability of LIBOR® or the Prototype Fallback Rates and/or Fallback Rates for any particular purpose to which it might be put, including with respect to the Prototype Fallback Rates and/or Fallback Rates. To the fullest extent permitted by applicable law, all implied terms, conditions and warranties, including, without limitation, as to quality, merchantability, fitness for purpose, title or non-infringement, in relation to LIBOR® and Prototype Fallback Rates and/or Fallback Rates, are hereby excluded and none of IBA or any of its affiliates will be liable in contract or tort (including negligence), for breach of statutory duty or nuisance, for misrepresentation, or under antitrust laws or otherwise, in respect of any inaccuracies, errors, omissions, delays, failures, cessations or changes (material or otherwise) in LIBOR® or Prototype Fallback Rates and/or Fallback Rates, or for any damage, expense or other loss (whether direct or indirect) you may suffer arising out of or in connection with LIBOR® or Prototype Fallback Rates and/or Fallback Rates or any reliance you may place upon it.
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