London Interbank Offered Rates (LIBORs) are being replaced by Risk-Free-Rates (RFRs) with the reform leading to multiple impacts on market participants, including changes in the way certain products and contracts operate
Policymakers around the world have determined that London Interbank Offering Rates (LIBORs) and LIBOR-derived benchmarks are no longer fit for purpose as they don’t reflect market financing practices and rely on ‘expert judgement’ rather than recorded transactions, which has made them susceptible to manipulation.
As a result, policymakers have initiated a transition from LIBOR to a new set of risk-free rates (RFRs), which comply with new international standards for benchmarks.
In some jurisdictions and for certain financial products, parties may not be able to reference benchmarks that fail to meet regulatory requirements, such as those found in the International Organisation of Securities Commissions (IOSCO) standards and the EU Benchmarks Regulation (BMR).
What are fallbacks?
The fallback language within a contract outlines the events and steps to be followed in order to produce an alternative reference rate if LIBOR is discontinued. In the case of derivatives, the International Swaps and Derivatives Association (ISDA) determined that fallback rates should be based on RFRs that are compounded in arrears plus a credit adjustment spread. This was agreed following extensive industry consultations with an intent to minimise the economic impact of the fallbacks. ISDA published the 2020 IBOR fallbacks Supplement and Protocol (2020 protocol) that parties can use to implement the fallbacks in existing transactions, with an effective date of 25 January 2021. ISDA have subsequently publish the 2021 ISDA Fallbacks Protocol (2021 protocol) and Benchmark Module to cover additional rates not in scope of the 2020 Protocol. The effective date of the 2021 protocol is 16 December 2021.
On March 5th 2021, the FCA announced that all LIBOR settings will cease to be provided by any administrator or be no longer representative from December 31st 2021 for all GBP, EUR, CHF and JPY settings and some USD settings, and from June 30th 2023 for all remaining USD settings.
What are the impacts?
The reform is having multiple impacts on market participants, including changes in the way certain products and contracts will operate. Some contracts may already contain detailed fall-back provisions, while others specify fall-backs which may create their own challenges. All the while, some others have no fall-back provisions at all. Parties need to make their own assessment of their contractual arrangements and of the impact of LIBOR cessation on their positions, and engage as necessary with their counterparties to discuss any form of amendment to insert fall-back arrangements or to actively transition to alternative rates. BNP Paribas is able to support its clients with reviewing portfolios in this manner.
There are also operational and IT impacts to consider, such as whether internal processes or systems are capable of handling LIBOR-linked products using fall-backs or transitioning to RFRs (e.g. from a ‘forward looking’ LIBOR fixing to a compounded in arrears i.e. ‘Backward looking’ RFR).
Firms must also be aware that if a product ‘falls-back’ to a different rate, it may no longer be suitable for its intended purpose, e.g. risk management/hedging an existing position. Market participants should also be aware of working group recommendations for ceasing of new LIBOR-linked transactions for certain products and be aware of the fast approaching (or passed) milestones (see BoE Milestones for GBP LIBOR and the Fed Supervision and Regulations Letter for USD LIBOR).
Changes to LIBOR as of 2022
On 4 January, 2022, the FCA confirmed the end of 24 LIBOR settings and reiterated that, with limited exceptions, new use of USD LIBOR is now prohibited, as is new use of ‘synthetic’ LIBORs. It also issued two notices:
- Requiring IBA to change the way LIBORs are calculated for the six synthetic GBP and JPY LIBOR settings, see more here
- Allowing use of synthetic rates in legacy contracts except for cleared derivatives
USD LIBOR restrictions
Regulators in the US and UK have released guidance regarding transitioning away from USD LIBOR, and stated that entering into new trades referencing USD LIBOR after 2021 (subject to limited exceptions) would create safety and soundness risks to the financial markets. In light of this, BNP Paribas has prepared a document focusing on the approach that the banke is taking in addressing the regulatory expectation on new USD LIBOR trades as of December 31, 2021. The remaining 5 US dollar LIBOR settings will continue to be calculated using panel bank submissions until mid-2023. However, new use of US dollar LIBOR is also now prohibited with limited exceptions. The US dollar risk-free rate SOFR is already being widely used in new business. Firms should now focus on converting their legacy US dollar LIBOR contracts by mid-2023.
How can BNP Paribas support clients?
“We have already signed up to the ISDA protocol to introduce the new fall-backs in our legacy derivatives transactions with other adhering entities, and started early in reaching out to our counterparts who have yet to adhere, to understand their plans regarding adherence or whether they will seek an alternative solution, and help them navigate the process.” commented Joe Squires, Co-Head of G10 Rates EMEA & GM Sponsor of the IBOR Transition Programme, BNP Paribas.
BNP Paribas is currently reviewing its position with regards to the 2021 Protocol and will be actively reaching out to impacted clients in due course.
We fully support the transition to RFRs and believe in taking a proactive approach to support clients with the changeJoe Squires, Co-Head of G10 Rates EMEA & GM Sponsor of the IBOR Transition Programme, BNP Paribas
BNP Paribas supports the market transition from LIBOR and is working with clients on new RFR transactions such as BMW’s largest corporate interest rate swap linked to the new risk free rate (RFR) to date, as well as the Associated British Ports which executed the first ESG SONIA swap repack in May, showing the broader implications of benchmark reform across financial markets.
BNP Paribas is also working closely with market participants, industry bodies and trade associations to ensure a smooth transition for clients and the industry. The steps include:
- Identifying the products which reference impacted interest rates
- Engaging with clients and counterparties on the potential consequences of the discontinuation of LIBOR
- Considering how different products may be affected
- In order to reduce our LIBOR footprint, and to assist clients, BNP Paribas is transitioning LIBOR-linked products to RFRs where relevant or appropriate