The End of USD LIBOR – and other tales

At the end of June 2023, USD LIBOR ceased publication. As with sterling transition 18 months earlier, a temporary synthetic LIBOR has been put in place to enable smooth transition for those legacy transactions not yet transitioned to SOFR, but the messaging is clear – LIBOR is done with, welcome to the world of risk-free rates (RFRs).

Other jurisdictions are following the lead of Sterling and the USD, with CAD, ZAR and others following suit over the next few years.

Irrespective of personal opinion whether transition away from LIBOR was the ‘right’ answer, it’s the answer that the market has come up with and, certainly in the UK, and increasingly in the USA and elsewhere, use of alternate reference rates (predominantly based off an overnight rate) have become business as usual.

Whilst the ACT remains interested to hear of any challenges that members are facing, we thought that we’d take this opportunity to summarize a number of useful resources for those days when you just can’t quite remember which jurisdiction is doing what – and what’s becoming standard practice in any particular market. 

Market practice will continue to evolve but here are a few things to bear in mind for circumstances where traditionally you might have assumed that LIBOR would be the reference benchmark:

• Consistency across markets
  • Both across jurisdictions and across markets in the same jurisdiction, market practice may differ so make sure that (to the extent you need them to), the terms of your contracts are consistent to minimize hedge ineffectiveness (whether that’s accounting or economic)
  • Fallbacks (in the event of non-publication of a reference rate) should not be assumed to be rational. 
    • There are contracts in existence that would ultimately fall back to a fixed rate in the event of non-publication – almost certainly not the intention.
    • As mentioned above, different markets may automatically fall back to different alternate rates, triggering economic ineffectiveness. 
    • As a side note: ‘Cost of Funds’ traditionally appeared in many loan agreements as the ultimate fallback – this might be viewed as a practical stop-gap. However, from the borrower’s point of view, this may not be ideal. Lenders’ cost of funds may not be reflective of an RFR-based rate and further, as the LIBOR experience illustrated, if a widely-used screen rate becomes unavailable, cost of funds quotations are unlikely to be practical to obtain on a market-wide basis.
• The Governing Law of contracts
  • Legislative solutions differ by jurisdiction, so for example contracts under New York Law have a different outcome to those under English law.

For more detail on these points and other negotiating consideration refer to: The ACT Borrower’s Guide to the LMA’s Investment Grade Agreements which has been fully updated to reflect transition to RFRs.

A note about the use of Term Rates

For corporates in particular, the use of term rates might seem like the obvious solution in the move away from LIBOR. However, whilst the corporate proportion of the market referencing LIBOR was a small percentage, the official sector identified a risk that the use of term rates could ultimately result in a replication of the LIBOR market, with the associated risks.

Therefore, generally speaking, the official sector (whether the FCA in the UK, the NY Fed, or the Financial Stability Board at a global level) have all expressed concerns about the adoption of a term rate as part of the IBOR transition ‘solution’. 

Use cases for term rates differ by jurisdiction but generally speaking are strongly discouraged in all cases.

One possible exception to this might be perceived to be in the USA where the use of a term rate is permitted for ‘business loans’. However, whilst certain relaxation of other use cases have been permitted, at the time of writing this note, the ability to hedge a term rate (i.e. the availability of term interest rate swaps) is very limited which will influence the pricing of such transactions.

Given that treasury systems generally are now enabled for overnight reference rates, the most cost-effective solution will be to transact ‘in the overnight’.

To Summarise

For the latest markets data, we’d recommend ‘going to the source’, so the RFR WG in the UK; the ARRC in the USA etc.

Both the Financial Stability Board (FSB) and IOSCO have published recent notes on LIBOR transition (and in particular the risks associated with the use of a Term Rate):

FSB: Final Reflections on the LIBOR Transition - Financial Stability Board (fsb.org)
IOSCO: Statement on Alternatives to USD Libor (iosco.org)

By currency, the ‘source’ information can be found at:

AUD: Market Operations Resources – Interest Rate Benchmark Reform in Australia | RBA
CAD: Canadian Alternative Reference Rate Working Group - Bank of Canada
CHF: The National Working Group on Swiss Franc Reference Rates 
EUR: Working group on EURO risk free rates
GBP: Risk Free Rate Working Group (RFR WG)
JPY: The Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks
SGD: Steering Committee for SOR & SIBOR Transition to SORA (SC-STS)
USD: Alternate Reference Rates Committee (ARRC)
ZAR: Market Practitioners Group (resbank.co.za)