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IBOR reform

What is changing?

One of the consequences mandated by the Financial Stability Board (FSB) in 2014 following the financial crisis was to initiate the replacement of benchmark interest rates such as London Interbank Offered Rate (LIBOR) and other interbank offered rates (‘IBORs’) by robust and reliable alternative replacement rates, a process hereinafter referred to as “IBOR Reform”. Consequently, some interest rate benchmarks will perform differently to the way that they do currently or some benchmarks, such as LIBOR, will disappear. Some uncertainties remain, but the roadmap and specific deadlines to replacement are becoming clearer.

This page focuses on the implications of the IBOR reform to your business and actions that you may need to take in order to be prepared for the biggest reform in the financial markets within last 40 years.


  • IBORs are designed to reflect the price of interbank funding markets. Each IBOR is published daily across a variety of currencies and tenors (e.g. overnight, oneweek, three-month, six-month), and predominantly based on submissions by a panel of banks. 

    Changes in interbank funding markets and financial distress situations have proved that IBOR panel bank submissions were based less on observable transactions, and predominantly on expert judgment. In July 2017, the UK Financial Conduct Authority (FCA), announced that by the end of 2021 the FCA would no longer compel panel banks to submit quotes for LIBOR.

    And in March 2020, in response to the Covid-19 outbreak, the FCA stressed that the assumption of an end of the LIBOR publication after 2021 has not changed. 

Latest developments

Cessation of LIBOR benchmarks

 

Given that LIBOR is widely used in various products and the volume of transactions referencing LIBOR is considerably large, the discontinuation may have a significant impact on both existing and future transactions, particularly in loans, bonds and derivatives.

On March 5, 2021 the Financial Conduct Authority (FCA) formally announced the dates of the future cessation or loss of representativeness of all 35 LIBOR settings currently published by ICE Benchmark Administration Limited (IBA).

The cessation of LIBOR settings is fragmented. All GBP, EUR, CHF, JPY, and some lesser-used USD LIBOR tenors (1W and 2M), will cease publication after 31 December 2021. The remaining USD LIBOR tenors will cease publication after 30 June 2023. Some GBP, JPY, and USD tenors will be non-representative after their respective cessation dates, allowing the FCA to potentially extend publication of these rates on a “synthetic” basis for use in “tough legacy” contracts only. 

    Risk Free Rates, new alternative replacement rates for LIBOR

  • A RFR, is calculated as a weighted average of executed traded volume in an overnight market. RFRs can be used as a benchmark to determine interest rates and payment obligations on numerous complex financial products from 2022, such as derivatives, bonds, loans, structured products and mortgages.

    Regulatory Sponsored Working Groups have been set up to select alternative RFRs across all major currencies.

    The Bank of England’s Working Group on Sterling Risk-Free Reference Rates (the “RFR Working Group”) has recommended using the Sterling Overnight Indexed Average rate SONIA. This has been adopted by the derivatives markets, with a growing number of bonds now using this index.  It has been published since 1997 but was reformed in 2018.

    In the US, the Alternative Reference Rate Committee (ARRC) has recommended the Secured Overnight Financing Rate (SOFR), a rate that is based upon a broad based secured US Treasuries repo’s It has been published since 2018.

    The National Working Group on Swiss Franc reference rates (NWG) is the key forum for considering proposals to reform reference interest rates in Switzerland. The NWG has recommended Swiss Average rate Overnight (SARON) to replace CHF LIBOR. SARON references actual market transactions in the Swiss franc interbank repo market (i.e. secured). It is published since 2009.

    The Cross Industry Committee on Japanese Yen Interest Rate benchmarks has selected Tokyo Overnight Average Rate (TONAR) / (TONA), which is an uncollateralized overnight call rate. It has been published since 2016.

    The Working Group On Risk Free Rates in the Euro Area has recommended the Euro Short Term Rate (€STR) as a replacement to EONIA overnight rate. €STR reflects wholesale Euro unsecured overnight borrowing costs of Euro area banks and has been published since the 2nd October 2019. Further details in €STR and EURIBOR benchmark will be provided under EURIBOR section below.

  • RFRs are described as ‘risk-free’ and are derived from actual transactions that have taken place in the liquid underlying markets. 

    There are some fundamental differences between LIBOR/IBORs and RFRs which will need to be addressed in the process of transition, including:

    Calculation direction - RFRs are backward looking overnight rates whereas LIBOR/IBORs are forward looking term rates. This means that for LIBOR the interest rate is fixed and publicly available at the beginning of each interest period. By contrast, the total interest accruing over a period based on a compounded RFR cannot be determined until the end of that period. A new lookback mechanism ensures that the parties know the interest that will be payable at the end of that interest period a few days in advance of the payment date. Therefore, we would recommend getting familiar with a number of new market conventions and calculation methodologies available within this backward looking approach across various financial assets.

    Credit and Liquidity Premiums – LIBOR/IBORs fixings include the cost of bank credit risk and term liquidity risk as they are calculated based on the submissions of panel banks at which rate they can borrow unsecured funds in the relevant interbank market, whereas RFRs are based on overnight transactions and do not have term structure. Transitioning existing contracts from LIBOR to RFRs may involve process incorporating a spread into RFR to cover the lender’s funding costs, etc.
  • The credit spread adjustment was developed to minimize the economic impact on a contract when its reference rate is switched from LIBOR to the applicable RFR, as LIBOR is a historically higher unsecured lending rate reflecting a credit risk component. There are a number of situations in which CAS may be applied, for example: the ISDA fallbacks for derivatives; or in fallbacks for cash products. A credit adjustment spread is calculated for each currency and tenor. The FCA’s announcement on the final cessation and non-representativeness of LIBOR tenors on March 5, 2021 had the effect of fixing the credit adjustment spread for each LIBOR currency and tenor. This means that market participants now have economic certainty for the transition to RFRs.
  • The derivative and loan markets have moved towards consensus in applying the historical 5 year median methodology for CAS for fallbacks. In the derivative markets, the ISDA has published an IBOR Fallbacks Protocol and Supplement to the 2006 ISDA Definitions.The protocol allows market participants to incorporate the revised fallbacks into their legacy non-cleared derivatives trades with other counterparties that also chose to adhere to the protocol. Bloomberg are now publishing these rates. 

    In the loan market, the amendment process of deals is manual. Each loan contract must be reviewed and amended by the parties before the final cessation of LIBOR fixings.

    An active transition prior the final cessation date may raise the discussions on the application of the second method to calculate a CAS. The forward approach based on forward looking basis swap market may be applied in both derivatives and loan markets. It is important to consider which approach to use when transitioning existing loans where there is hedging in place. Please be aware of the potential mismatches between linked products and consult your usual relationship contacts on this subject.

  • Not for majority of financial assets at the current stage.
     
    The market participants have called for the development of forward looking term rates derived from RFRs (term RFRs) for each LIBOR currency and tenor. Like, LIBOR, term RFRs would make it possible to calculate the interest payable over an interest period at the beginning of that interest period.

    However, the UK regulators made it clear that a Term SONIA is required for certain financial assets and specific customer groups:

    • Small and medium size businesses
    • Trade Finance and Working Capital products
    • Export Finance

    The US regulators have chosen a different approach. On 29 July 2021, the US Alternative Reference Rates Committee (ARRC) announced that it formally recommended the forward Term SOFR published by CME Group, Inc. (CME) for use in connection with business loans.

    This announcement is significant for syndicated loans denominated in US Dollars for two principal reasons. First, the ARCC's recommendation of a Term SOFR is the first step in the waterfall in the ARRC's recommended LIBOR fallback language for loans and for many other financial products under the US law. Consequently, when a trigger event occurs, Term SOFR would become the LIBOR replacement in many loan agreements after June 30, 2023.

    Secondly, Term SOFR may also be seen as a competitor especially for bilateral deals to the backward–looking RFRs in the corporate segment.

    However, Term SOFR is not generally recommended for use in derivatives, with limited exceptions (including a hedge of a SOFR loan or other cash product). The limited use cases for Term SOFR reflect a concern that trading in Term SOFR may detract from liquidity in overnight SOFR, which would render that rate less robust.

    If you are interested to find out more about Term SOFR use cases, please contact your loans and derivatives specialists in the relationship banks.

    In Japan, there are several candidates for alternative benchmarks to replace LIBOR. One of them is Tokyo Term Risk Free Rate (TORF) calculated and published by QUICK. However, the use of compounded TONA in arrears currently prevails for alignment purposes in the multicurrency business loan agreements. 


    The National Working Group on Swiss Franc Reference Rates is not intending to develop a term rate for SARON. 

    The Working Group on Euro Risk Free rates has not released a target date for when it expects to publish a term rate.

    The FCA has advised on numerous occasions that market participants should not delay the transition until term rates arrive and start applying new alternative replacement rates as soon as practicable.

    Developments in other currencies

  • On July 2,  2019 the European Money Market Institute (EMMI), the administrator of EURIBOR, was granted the authorisation by the Belgian Financial Services and Markets Authority (FSMA) the right to administrate EURIBOR under Article 34 of the EU Benchmarks Regulation. This means that EURIBOR was transitioned from a quote –based EURIBOR methodology to the new hybrid methodology. The transition was seamless and did not require any specific amendments of the existing contracts.

    For more detailed information, please follow the link below:
    EMMI - European Money Markets Institute | REFORM (emmi-benchmarks.eu)
  • On October 2, 2019, the new EURO short-term rate (€STR) was published for the first time by the European Central Bank (ECB). On the same date, EONIA stopped as an independent fixing. Instead, EONIA is currently calculated as €STR plus a fixed spread of 8.5 basis points (bp.)

    In order to give the markets time to transition fully to €STR, EONIA will continue to be published until the end of 2021. As of January 3, 2022 EONIA will no longer be published. For more information, please follow the link below:
    EMMI - European Money Markets Institute | About Eonia® (emmi-benchmarks.eu)
  • CIBOR is not a critical benchmark. The Danish Financial Benchmark Facility (DFBF) has not shared any plans nor intentions for discontinuation of this benchmark. Therefore Danske Bank A/S continues using CIBOR without any changes. 

    However, as central banks in other countries are reviewing the alternative rates to IBORs, the National Bank of Denmark has accepted to become the administrator of the new Danish reference rate, DESTR, scheduled to be launched in the beginning of 2022 following the test period in 2021.  For more information, please follow the link below:
    Transaction-based reference rate (nationalbanken.dk)
  • STIBOR is a critical benchmark and needs to be reformed by the end of December 2021. On March 1, 2021 the Swedish Financial Benchmark Facility (SFBF) has published a public consultation on the Evolution of STIBOR that presents a comprehensive review of the definition of STIBOR and the calculation methodology, together with proposed adjustments to increase the robustness of the benchmark. Danske Bank A/S is following the developments and if you have any questions on your contracts, please contact your usual relationship contact. More information about the consultation is provided in the link below:
    Public Consultation - Swedish Financial Benchmark Facility (swfbf.se)


    On January 27, 2021 the Riksbank started the testing of the Swedish Krona Short Term Rate (SWESTR), a rate that is a transaction based reference rate calculated based on the basis of transactions executed on the money market from one banking day to the next in Swedish kronor. SWESTR shall not be used in any financial contracts during the test period. On September 2, 2021 the publication of SWESTR has been officially started.

    For more information, follow the link below:
    SWESTR | Sveriges Riksbank

  • Norske Finansielle Referanser (NoRe) is from January 1, 2017 the administrator for NIBOR. NIBOR is not a critical benchmark and therefore Danske Bank A/S continues using this benchmark in the financial contracts.

    In early 2018 a working group on alternative Norwegian krone reference rates was established by the Norges Bank. On January 1, 2020 the Norges Bank took over the role of an administrator of Norwegian Overnight Weighted Average (NOWA) daily rate.  The working group on alternative reference rates has focused on two working directions: 

    1. Market standards and fallback solutions for NOWA
    2. Establishment of an OIS market in NOK using NOWA

    Multiple consultations on NOWA were published by the working group of Norges Bank in 2020. The Norwegian market is the most advanced in its progress on an alternative daily rate application among the Scandinavian countries. For more information, please follow the link below:
    Documents from the working groups on alternative reference rate (norges-bank.no)

  • In Asia, most of the jurisdictions plan to adopt a multiple-rate approach for their respective local benchmark reforms, with enhanced benchmarks expected to remain alongside alternative RFRs. For example: for HKD contracts, enhanced HIBOR is expected to continue alongside HONIA. 

    On 12 November 2020, the administrator for CDOR issued a public statement that it will cease to provide the 6-month and 12-month CDOR tenors from 17 May 2021 onwards and that the last day of publication for these tenors will be 14 May 2021. It means that the market participants may continue using the most popular 1-month and 3-month CDOR tenors without any interruption.  
    6-month and 12-month CDOR tenors have an option to switch to CORRA after the cessation date. 

    For more details on each specific currency, please contact your usual relationship contact.

    What does it mean for me as a Danske Bank customer?

  • The regulators in each jurisdiction of LIBOR currencies have provided the recommended interim deadlines for the transition that supplement the FCA’s statement on the final cessation and non-representativeness of LIBOR benchmarks.

     

    If you need more information on the specific action plan in each jurisdiction, please check the section "More information on the IBOR reform" below.

     

    Download the transistion deadlines table here

  • Taking into consideration that the LIBOR cessation date is rapidly approaching and regulatory authorities strongly encourage market participants to seek to significantly reduce their LIBOR exposures sufficiently in advance of the end of 2021, we would like to invite you to consider the following option:

    An amendment of your current committed business loan agreement to include a pre-agreed conversion mechanism (a so-called “Rate Switch” mechanism). The Rate Switch mechanism facilitates the change from an initial term rate such as LIBOR to a compounded RFR (or daily simple average RFR and/or other alternative benchmark derived from RFR, where applicable) on a mutually agreed date in 2021(for GBP, CHF and JPY) or in 2023 (for USD).

    The amendment of your credit agreement to include a Rate Switch mechanism will incorporate the mechanics and provisions necessary for automatic transition to the selected RFR based rate, thereby mitigating the risk in 2021 or in 2023 (depending on the currency and jurisdiction), when LIBOR is declared to be non-representative. 

    You should expect that the amendment process would take some time in order to reach the agreement on multiple currencies and lenders. Therefore, we encourage you to contact us at your earliest convenience and start discussing the transition strategy now.

    In any event, we recommend that you familiarise yourself with RFRs and consider transacting to RFR referenced loans in your new deals as well. Please feel free to reach out to our loan professionals with any questions you may have in relation to LIBOR transition, new conventions for use of RFRs in relation to loans or the transition/amendment process. We will do our best to answer your queries. 

    You can find more information about IBOR reform in our FAQs and the webinar at the section "Danske Bank's webinars and FAQ's".
  • When transitioning your IBOR derivatives to the RFR rates be aware of whether these are linked to loans or other instruments that have an IBOR reference. If your derivatives are linked somehow, it is recommended that you aim for similar conventions for the derivative and the linked instrument. By failing to do so there is a risk of a mismatch in terms of economics and accounting. 

    We recommend that you get an overview of the fallback rates in your derivatives contracts and consult with your external advisors on what actions are needed. Please be aware that it is possible to adhere to the ISDA 2020 IBOR protocol if you have an ISDA Master Agreement. By adhering to the protocol the fallback language in your legacy derivatives will be amended with ISDA’s fallback rates. Whether this is suitable or not depends on the nature of your derivatives as well as their potential link to bonds and/or loans. You will need to consult your external advisors on this matter, and you can find more information and adhere to the protocol by following this link: www.isda.org/protocol/isda-2020-ibor-fallbacks-protocol/.

    If you adhere to the protocol please be aware that it should not be seen as the final step in your transition. Regulators have frequently stated that the fallback rates should not be used as a mean of transition away from IBOR derivatives to RFR derivatives. Thus, we recommend that you restructure your IBOR derivatives into RFR derivatives prior to the cessation of the relevant IBORs. Not only will it be in accordance with the regulators guidance and intention. It will also mitigate your operational risk by ensuring that your IT infrastructure can cope with the new RFR rates, their compounding etc.

    Finally, note that if your derivatives are cleared on LCH (London Clearing House) the transition is planned to happen automatically for non USD LIBORs by the end of 2021. For derivatives with a reference to USD LIBOR, that would be prior to 30th of June 2023.

  • Identification of LIBOR-linked contracts
    As a first step, you need to identify where your LIBOR exposures are. You also need to examine whether the contracts mature beyond the end of 2021. It is important to note that LIBOR may be used not only in loans, bonds and derivatives, but also other areas such as intra-group accounts.

    Review your contract terms and conditions
    Some of your contracts may not include fallback language related to permanent LIBOR        
    discontinuation. You need to review and amend terms and conditions as necessary.

    Operational readiness
    You may need to update systems and infrastructure for the changes. Especially, the backward looking RFRs will require new IT development and the resources shall be attributed to this task with no further delay. 

    Communication with your relationship banks
    You should communicate with your relationship banks regarding preparation to IBOR’s transition and impacts on your businesses.

    You may also want to engage independent consultants for advice, in particularly reviewing your exposures, potential impact for accounting and taxes, treasury management systems and processes that LIBOR discontinuation may have on you and your business.

Disclaimer

Please be advised that this page contains general information. It does not contain recommendations of any kind. You can always contact your regular contact person in Danske Bank if you wish to receive individual information about the IBOR Reform and how it impacts you.


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