The financial industry has had little time to catch its breath following the surge of activity leading up to the cessation of sterling, Swiss franc, Japanese yen, euro, and one-week and two-month USD LIBOR settings on December 31, 2021. However, work is still very much ongoing, in regards to the remaining USD LIBOR.
Bank of England Governor Andrew Bailey congratulated the results so far, saying: “That most LIBOR settings ended at end-2021 with minimal disruption is a testament to the cooperation across a wide range of industry sectors and jurisdictions.”
For GBP LIBOR the UK Financial Conduct Authority (FCA) and Bank of England estimate that across all asset types less then 2% of the total sterling LIBOR legacy stock remains, and they are clear that synthetic LIBOR is a temporary solution. The FCA will seek views this year on retiring one-month and six-month synthetic sterling LIBOR at the end of 2022, and on when to retire three-month sterling synthetic LIBOR.
Now the foundations are being laid for the cessation of the remaining USD LIBOR settings after June 30, 2023. Regulators made clear when extending the timeframe to June that there should be no loss of momentum in remediating these remaining settings. To that end, U.S. regulators and industry bodies such as the Alternative Reference Rates Committee (ARRC), in its recommended best practices document have set clear and consistent milestones to ensure progress stays on track over this timeline. Meanwhile, ongoing regulatory and legislative developments are shaping the industry’s transition plans and approaches to remediation.
Federal LIBOR Legislation
The ARRC recently welcomed federal LIBOR transition provisions included in the “Consolidated Appropriations Act, 2022,” which was signed into law by President Biden in March 2022. The legislation applies to all US law contracts and supersedes all similar state legislation. Key points include:
- A process to replace LIBOR in existing contracts that mature after the cessation of USD LIBOR and have no effective means to replace LIBOR;
- A safe harbour for lenders if they choose the Secured Overnight Financing Rate (SOFR) in contracts where a party has the discretion to select a successor rate; and
- A Board-Selected Benchmark, identified by the Federal Reserve Board as the replacement rate, based on SOFR (e.g., Term SOFR or Compounded SOFR).
ISDA Protocol Adherence
Regulators worldwide continue to encourage adherence to the International Swaps and Derivatives Association’s (ISDA’s) protocols as an efficient way to incorporate industry-standard fallbacks into agreements. These include:
- ISDA 2020 IBOR Fallbacks Protocol: For uncleared derivatives this continues to be a popular approach across the industry, and the majority of financial services organizations have adhered. Many of those that haven’t adopted the protocol are companies outside the financial industry who often prefer to bilaterally amend their LIBOR contracts or actively transition LIBOR trades. However, the protocol can also provide a backstop for those actively transitioning or a solution for vanilla trades while bilateral amendments can take place for more structured transactions.
- December 2021 Benchmark Module of the ISDA 2021 Fallbacks Protocol: This newly released protocol expands fallback arrangements to additional IBORS including: MIFOR, PHIREF, NIBOR, BKBM Bid, BKBM FRA, KLIBOR, STIBOR, and SIOR. Adherence to this protocol for these USD LIBOR-based benchmarks is being encouraged across the industry.
Term SOFR
The CME Group’s forward-looking Term SOFR was formally recommended in July 2021 by the ARRC, which went on to publish best practice recommendations for its use. In January 2022, the CME published FAQs about its use in line with the ARRC’s recommendations. Most notably in the derivatives market, use is limited to transactions intended to hedge cash products by end users.
In March 2022 the Intercontinental Exchange’s ICE Benchmark Administration (IBA) launched ICE Term SOFR Reference Rates as a benchmark for use in financial instruments. “We are providing financial markets with an additional tool to support benchmark transition,” said IBA President Tim Bowler. “ICE Term SOFR is designed to help businesses, borrowers, and lenders who value having forward-looking term rates in order to provide certainty when calculating their interest expenses and other contractual payments in advance.”
Looking Ahead to Q2 and Beyond
The industry will continue to plan for and execute on USD LIBOR remediation. Key considerations for market players include:
- The role of the federal legislation and the balance against proactive remediation strategies as encouraged by regulators;
- Outstanding elements of the federal legislation (e.g., the 180-day window for the specific SOFR methodology to be determined);
- Steps that can be taken upfront to avoid capacity constraints leading up to cessation, given USD volumes (e.g., proactive agreement outreaches and early trade fallback application in systems);
- The potential for ISDA to expand fallback arrangements with further modules to the ISDA 2021 Fallbacks Protocol and
- The approach the FCA will take to the annual review of GBP and JPY synthetic LIBOR.