LIBOR Transition Customer Frequently Asked Questions
(May 2020)

Since the financial crisis in 2008, shrinking underlying transaction volumes and a reduction in the number of contributing LIBOR panel banks has resulted in systemic risk concerns about LIBOR. LIBOR’s demise was set when the Financial Conduct Authority (FCA), which oversees the administrator of LIBOR, announced it would stop compelling panel banks to submit LIBOR estimates at the end of 2021. As a result, it is expected that LIBOR will cease being published.The FCA confirmed in March 2020 this timeline has not changed as a result of the COVID-19 pandemic.

Work is being done around the world to reform LIBOR and other benchmark rates. Even if your financial products, transactions or services do not reference LIBOR, you do need to consider the reforms being undertaken in other benchmark rates. For example, you may be asked to amend your contracts to include fallback language for non-LIBOR rates.

LIBOR is published in five currencies – USD, GBP, JPY, EUR, and CHF. Instead of LIBOR, each country has determined what alternative overnight risk free rate (RFR) will apply. The RFR for each of the LIBOR currencies is set out in the table below:

There are four IBOR benchmark rates that will also need to be replaced due to their dependency on USD LIBOR.
The replacement rate for SGD SOR is the Singapore Overnight Rate Average (SORA) and for THB THBFIX it is the Thai Overnight Repurchase Rate (THOR). The replacement rates for INR MIFOR and PHP PHIREF are still in development.

Australia and New Zealand have adopted a “multiple rate approach”.

In Australia, BBSW (Bank Bill Swap Rate) (and the Bank Bill Swap Bid Rate (BBSY)) will co-exist with the Reserve Bank of Australia’s Cash Rate (commonly known as AONIA (AUD Overnight Index Average)). AONIA is the alternative RFR for the Australian dollar.

In New Zealand, BKBM (Bank Bill Benchmark Rate) will co-exist with the Reserve Bank of New Zealand’s Official Cash Rate (OCR). The OCR is the alternative RFR for the New Zealand dollar.

As markets transition away from using LIBOR to RFRs, there may be some corresponding movement away from LIBOR to these RFRs. This will depend on how international markets for products such as cross currency swaps end up transitioning away from LIBOR.

Fallback language refers to the contractual provisions that set out the process to be followed in the event LIBOR (or any other benchmark rate) is not available. The language acts as a how-to guide for identifying a replacement rate if LIBOR is not available.

Generally, existing fallbacks for LIBOR in derivative contracts are only intended to apply when LIBOR is temporarily unavailable. When this happens, the fallback is to call for a dealer poll of quotes. If LIBOR is permanently discontinued, it is likely that major dealers would be unwilling and/or unable to quote a rate. Even if quotes were available in the near-term after a permanent discontinuation, it is unlikely they would be available for each future reset date over the remaining term of long-dated contracts. It is also likely that quotes could vary materially across the market.

ISDA will be updating the 2006 ISDA Definitions for the LIBOR fallbacks. Each affected currency will have a specific set of fallbacks. Generally, the structure of the proposed fallback waterfall for LIBOR is:

1. Adjusted RFR (i.e. overnight daily compounded RFR + spread adjustment)
2. Recommended replacement rate for RFR (as formally recommended by the central bank or other supervisor)
3. Central bank rate + spread adjustment

ISDA is expected to publish the LIBOR fallbacks during Q2 2020. The effective date for LIBOR fallbacks is expected to be four months after the publication date. Any new derivative trades using the 2006 ISDA Definitions entered into after the effective date will automatically include the new LIBOR fallbacks.

Derivative trades entered into before the effective date will not automatically include these LIBOR fallbacks. ISDA will release a Protocol at the same time as updating the 2006 ISDA Definitions to cover this legacy trade population. Both parties must adhere to the Protocol for the LIBOR fallbacks to apply to the legacy trades. If one party does not adhere to the Protocol then the existing fallbacks remain unless the parties separately agree to the applicable LIBOR fallbacks for their trade. This approach will take a lot longer.

Parties need to consider a range of issues such as the effect of the Protocol on the transaction, or if the derivative is linked to, or hedges, a related loan facility or other cash product, how the fallbacks will affect that product, what fallbacks are contained in that product, and the impact on the hedge.

RFRs are overnight rates and do not include a term structure or credit spread. RFRs are also risk-free (or nearly risk-free) and may be secured or unsecured. By contrast, LIBOR is forward-looking and is an unsecured term rate quoted for different tenors. LIBOR also includes a bank credit risk component. Because LIBOR and RFRs are not economically equivalent, to account for the economic difference between LIBOR and the RFRs, a spread adjustment is needed.

The spread adjustment for derivatives will be a static number that is calculated once the LIBOR cessation event is publicly announced. The spread adjustment for derivatives will be based on the 5-year median of the LIBOR-RFR spread. The spread adjustment is added to the RFR rate and is intended to minimise the difference between the RFR and the LIBOR rate.

AUD BBSW, CAD CDOR, CHF LIBOR, EUR LIBOR/EURIBOR, GBP LIBOR, HKD HIBOR, JPY LIBOR/TIBOR/Euroyen TIBOR, USD LIBOR.

Other currencies will be addressed by ISDA in separate definition updates.

In countries like Australia, New Zealand, Europe, Japan, Hong Kong and Singapore, new overnight RFRs are being published, but the existing benchmark rates will continue. While there is a lesser risk of a permanent cessation event for benchmark rates in these countries’ currencies, market liquidity may shift into using the new RFR. Contractual fallbacks will need to be made more robust for these currencies over time.

Bloomberg has been selected by ISDA to publish the spread adjustment for derivatives. Bloomberg will publish the RFR, the spread adjustment, and the all-in rate for selected tenors.

No. While the LIBOR fallbacks are intended to produce a result that is comparable to LIBOR, unlike LIBOR which includes credit and term premium that change over time, the RFR spread adjustment is fixed and will not reflect changing market conditions.

ANZ is currently reviewing drafts of the Supplements to the 2006 ISDA Definitions for the LIBOR fallbacks and the Protocol.

The Protocol is the way in which ISDA enables adhering parties to amend derivative transactions and agreements with other adhering parties. The Protocol applies to derivative transactions and agreements entered into before the effective date of the LIBOR fallback changes to the 2006 ISDA Definitions. Counterparties may exclude agreements (including confirmations) from the operation of the Protocol by written agreement. The operational impact of some agreements being covered by the Protocol and others not (and needing bilateral amendment to include robust fallbacks) needs to be carefully considered by the parties.

A permanent cessation trigger is an announcement by an administrator of the benchmark or a regulator that the benchmark will no longer be published from a particular date. A pre-cessation trigger is an announcement by a regulator that LIBOR is no longer representative but where the benchmark rate is still being published. 

Yes. Industry consensus was to include both permanent and pre-cessation fallbacks in the amended 2006 ISDA Definitions for LIBOR.

The Alternative Reference Rates Committee (ARRC) has published recommendations for interdealer cross-currency swap market conventions. The recommended conventions cover:

• RFR-RFR cross-currency swaps
• RFR-LIBOR cross-currency swaps
• Potential fallbacks for cross-currency swaps referencing LIBOR.

The USD floating leg will change to daily compounded SOFR. In the dealer-to-dealer market, a non-USD floating leg may reference the RFR if there is one or IBOR if there isn’t, i.e.

• A EUR/USD floating/floating XCCY may be quoted:  €STR/SOFR
• An AUD/USD floating/floating XCCY may be quoted:  AONIA/SOFR
• A SGD/USD floating/floating XCCY may be quoted:  SORA/SOFR

In the dealer-to-customer market it maybe the same as the interbank market or it can be IBOR to RFR.

• An AUD/USD floating/floating XCCY may be quoted:  BBSW/SOFR

This will depend on customer needs.

Currently the other leg would stay as an IBOR. ISDA is considering providing a template to allow both legs to move to their fallbacks in the event one leg has a cessation event.

The current overnight benchmark for the major currencies is used to pay the margin interest rate (known as Price Aligned Interest or PAI). This matches the currency for the eligible collateral being posted. For example the Effective Fed Funds Rate (EFFR) is used as the PAI rate on the posting of USD cash collateral. This rate is also the discount rate used to value the trade. Similarly, when it comes to posting of EUR cash collateral, EONIA is the PAI rate and the discount rate.

The central clearing houses (LCH, CME etc.) are planning to switch from EFFR to SOFR for discounting and PAI in October 2020 and from EONIA to €STR in July 2020. These changes may result in an increased demand to amend CSA’s to reflect these new benchmarks to minimise any discounting basis risks.

Note: CSAs that reference EONIA will have to be renegotiated to reference €STR, as EONIA will be discontinued at the end of 2021.

Because there is a lack of industry standard documentation across lending products, fallback provisions vary from deal to deal, and some contracts may not contain fallback provisions at all. Where they are included usually the waterfall of fallbacks is as follows: 

Generally existing loan fallbacks only apply when a rate becomes temporarily unavailable (the “Screen Rate” being the relevant benchmark rate).

The market recognises legacy fallback options were not intended to cater for a permanent cessation scenario. In particular, because the fallbacks themselves are based on LIBOR rates they do not work once LIBOR is permanently discontinued and replaced by a rate that is calculated on a different methodology entirely. Existing fallbacks also do not include the ability to adjust credit spreads to “re-balance” the economic equation.

In the loans and cash products space, there is no industry standard suite of agreements equivalent to ISDA Master Agreements. Facility Agreements are negotiated on a deal-by-deal basis. That said, lending documents that reference IBOR rates follow similar conventions – interest is comprised of LIBOR plus a margin, interest periods are selected by the borrower and the rate is set at the beginning of the relevant interest period, with the interest payment falling due at the end of that period.

Because of the structural differences between LIBOR and RFRs, it is not a simple case of “like for like” substitution. During the early stages of the transition to RFRs, this is going to create challenges, particularly in syndicated loans where multiple financial institutions will need to agree on rate calculation methodologies and fallbacks. This will be even more pronounced for multi-currency facilities as RFRs for different currencies may have different characteristics and may be published at different times.

The expectation is that as RFRs begin to gain market acceptance, RFR market conventions will emerge. Template documentation will be published by loan industry bodies to reflect that market consensus. In the meantime, loan industry bodies have published consultation drafts for market participants to consider and use in one-off transactions (where the lender and customer are both ready to use RFR).

Provisions have been included in loan contracts to accommodate LIBOR cessation. 

• Screen Rate Replacement language. The European Loan Market Association (LMA) and the Asia Pacific Loan Market Association (APLMA) published the so-called “replacement of screen rate” rider for insertion into primarily syndicated and club agreements.

The clauses in the rider do not include alternative fallback rates, but are intended to serve as an acknowledgement between the parties that if a benchmark rate cessation trigger event occurs (for example, the benchmark is discontinued or is no longer deemed to be representative or appropriate for calculating interest), the parties will agree an alternative benchmark rate and make the necessary changes to the contractual arrangements, and to the economics of their transaction, to implement it.

In syndicated loans, the provisions are also intended to simplify the amendment process by lowering the consent threshold. ANZ has been incorporating “replacement of screen rate” provisions into new and amended lending documents since late November 2018.

• LMA’s Exposure Drafts. The LMA has published exposure drafts of single-currency facility agreements for sterling and US dollars  with pricing based on RFRs (SONIA/SOFR) calculated on an in arrear basis with a “lag” period. These drafts do not provide fallback language for existing LIBOR deals, but are intended to facilitate discussions about how new deals based on RFRs will be documented and priced. The proposed rate waterfall in the exposure drafts is as follows:

The “Primary Screen Rate” is essentially an externally produced compounded average of the RFR made available by an information provider. There is currently no Primary Screen Rate for any LIBOR currency.

The LMA is requesting feedback from the market on commercial issues raised in the drafts and commentary document accompanying them, and ANZ will be monitoring any published responses or the LMA’s observations from feedback received on the drafts.

The ARRC in the US is responsible for the transition away from USD LIBOR to SOFR. The ARRC has published suggested fallback provisions for use in bilateral facilities, syndicated facilities, floating rate notes and securitisations.

RFRs are overnight rates and do not include a term structure or credit spread. RFRs are also risk-free (or nearly risk-free) and may be secured or unsecured. By contrast, LIBOR is forward-looking and is an unsecured term rate quoted for different tenors. LIBOR also includes a bank credit risk component. Because LIBOR and RFRs are not economically equivalent, to account for the economic difference between LIBOR and the RFRs, a spread adjustment is needed.

The UK Working Group on Sterling Risk-Free Reference Rates (for GBP LIBOR) and the ARRC (for USD LIBOR) has consulted with industry on the credit spread adjustment applicable to loans. There are outstanding be used a cessation. Both consultations identified a strong consensus in favour of the approach adopted by ISDA (i.e. the historical 5 year median of the LIBOR-RFR spread).

A forward-looking term rate is one that is fixed and publicly available at the beginning of an interest period and is quoted for a range of different maturities. The primary example of such a rate is LIBOR.

By way of contrast, RFRs are backward looking overnight rates. This means interest is calculated daily using the relevant overnight rate and cannot be calculated in advance.

The UK Working Group on Sterling Risk-Free Reference Rates has said that market participants should not wait for forward-looking term rates to become available, although they have also said that forward-looking term rates may be more appropriate than overnight RFRs for a limited number of products and customer types.

Provisional SONIA forward-looking term rates are forecast to be available by Q3 2020. SOFR forward-looking term rates are not expected to be available until mid-2021. There is no certainty term rates will be published. It is also unknown whether forward-looking term rates will be endorsed by regulators or if forward-looking term rates will be available in other currencies.

At this stage, due to the uncertainty as to whether and when forward-looking term rates might be available and whether they will be endorsed by regulators, market participants are preparing for a transition from LIBOR rates to RFRs on the basis that no forward-looking term rates will be available.

Unless the product requires discounting (like trade receivables), you may want to consider planning for loan facilities to use compounding overnight rates.  

While industry bodies representing the loan market and ISDA are trying to establish consistency across product types, their members may have differing views on product specific requirements (e.g. first fallback for loans is a forward- looking term RFR (if one exists)).

Parties to loan documents that reference a LIBOR rate will have to agree and document amendments to their loan documents to reference alternative rates and/or robust fallbacks. This may take time. 

Various loan and other market associations are consulting market participants with a view of developing guidance on the transition from LIBOR to RFRs. The process for replacing LIBOR with RFRs may be driven by either the borrower or the lender.

Once the most appropriate strategy for transitioning has been agreed between the borrower and the lender (and will most likely follow guidance from the relevant loan market association and be dependent on the emergence of market conventions), the facility agreement will need to be amended to reflect the RFR-related amendments. The specific transition process will depend on the terms of each facility agreement and will therefore need to be managed on a case by case basis.

Various loan and other market associations are consulting market participants with a view of developing guidance on the transition from LIBOR to RFRs. The process for replacing LIBOR with RFRs may be driven by either the borrower or one or more syndicate banks and will be coordinated by the facility agent.

Once the most appropriate strategy for transitioning has been agreed (and will most likely follow guidance from the relevant loan market association and be dependent on the emergence of market conventions), the syndicated facility agreement (SFA) will need to be amended to reflect the RFR-related amendments.

We expect that most SFAs entered into (or amended and/or restated) since the end of 2018 will allow LIBOR replacement amendments to be approved by the majority lenders. However, the specific transition process will depend on the terms of each SFA and will therefore need to be managed on a case by case basis.

Various loan and other market associations are consulting market participants with a view of developing guidance on the transition from LIBOR to RFRs. The process for replacing LIBOR with RFRs in a club deal (i.e. a multi-lender deal arranged by the borrower that does not involve a syndication process) involving a common terms deed may be driven by either the borrower or one or more of the lenders.

Once the most appropriate strategy for transitioning has been agreed (and will most likely follow guidance from the relevant loan market association and be dependent on the emergence of market conventions), the facility agreement and/or the common terms deed will need to be amended to reflect the RFR-related amendments. The specific transition process will depend on the terms of each facility agreement and (to the extent relevant) the common terms deed and will therefore need to be managed on a case by case basis.

If the common terms deed also needs to be amended, other lenders and the agent (if applicable) may also need to be involved in the process. 

Products that require discounting like trade receivables and payables may need forward- looking term rates. However, it is unclear whether forward-looking term rates will be available in time. The industry is still assessing the appropriate solution for these products.

A FRN that references a RFR may function differently from a LIBOR referencing FRN. Investors in LIBOR based FRNs are compensated with higher coupon payments when wholesale funding costs rise. However, FRNs referencing the RFRs may not deliver this outcome. In times of crisis coupon payments may fall due to the RFR being closely aligned to the official cash rate. 

This depends on the terms that govern the FRN. In the UK, the bond market uses consent solicitation to seek bondholder consent to amend the terms of LIBOR referenced FRN. For GBP FRN issues, the level of bondholder consent is generally 75% to amend the applicable interest rate. By comparison, USD FRN issues typically require 100% bondholder consent to amend the applicable interest rate. FRN issuers need to take this into account when considering how to amend the applicable interest rate for their outstanding FRN.The ARRC has proposed a legislative solution to address USD LIBOR cessation (this includes the amendment of New York law governed FRNs). This is only a proposal.

The ARRC has published recommended fallback contract language and guidance notes for FRNs. Guiding principles for fallback provisions have been issued by the European Central Bank for Euro area risk free rates.

SOFR is a combination of 3 overnight US Treasury repo rates. The repo rate is the rate at which investors offer banks overnight loans using US Treasuries as collateral. As SOFR is a repo rate, SOFR has been volatile at times when the underlying US Treasury repo market is also volatile. SOFR can experience spikes at quarter and year end because of bank balance sheet repositioning. These one day spikes typically reverse soon afterwards.

Contracts that reference SOFR use an average of the daily rate over a fixed period rather than a single day’s rate. Average SOFR is typically less volatile than LIBOR.

LIBOR is a forward-looking term rate (i.e. the rate and the interest amount due are known at the start of the interest period but the interest payment is not made until the end of the period). This gives borrowers cash flow certainty in advance of the interest payment for a particular interest period.

For example, in the case of a 3 month interest period, borrowers know 3 months in advance of an interest payment date what the interest payment amount will be on the interest payment date.

Daily RFRs work differently. To calculate the interest amount payable, all of the daily rate fixings for the interest period need to be known beforehand. The final interest amount can only be calculated at the end of the period. A borrower will not know at the beginning of the interest period what interest amount is payable on the interest payment date. Cash flow certainty will be significantly reduced compared to a LIBOR instrument. Industry is considering a number of options such as backward shifting the observation period for a certain number of business days for the calculation of interest to try to alleviate this issue.  

Alternatives include changing to a fixed rate, using an alternative base rate or using the lender’s cost of funds rate. However these rates may not be suitable for your particular circumstance.

To minimise the value transfer an adjustment spread can be added to the RFR rate. Given the lack of transactions referencing RFRs at this stage, it is difficult to comment on the effectiveness of particular spread adjustment methodologies (as they are largely untested) in addressing the value transfer, and concerns associated with this. The concerns are equally applicable to both ANZ and the customer.

ANZ is not able to provide you with legal, tax or accounting advice. You should seek independent legal, accounting and tax advice on the transition from LIBOR to RFR.

Potential differences in fallback methodology between different product types may complicate the transition. The impact of a transition of any products that are linked (such as a loan and hedge) must be carefully considered.

Customers should look at their existing loan, trade, derivative and accounting systems to ensure they can support the calculations of the new RFRs. System upgrades can typically take a long time, so any upgrade work should be prioritised.

The change to RFR for each affected currency is developing at different speeds. The transition may occur in rolling stages as liquidity builds in the RFR for each currency so that a transition can take place. Product and infrastructure development is also quite fragmented. This may impact the timing of the transition.

ANZ is conducting due diligence to review and confirm how LIBOR and other IBORs are used in ANZ products or services. It is not yet possible to accurately determine the precise impact on all parties until replacement rates (and any necessary spread adjustments) are confirmed at industry level and until more information is known on the timing of the changes.

Closely monitoring the market, participating in industry consultations and preparing for an orderly transition are priorities for ANZ.

ANZ’s current view is that derivatives are most likely to lead the way in transition from a product perspective. It’s unlikely much will happen before the end of Q2 2020 as the market waits the finalisation of the ISDA LIBOR fallbacks and the publication of the Protocol.

For cash products, the expectation is that as alternative rates begin to gain market acceptance, there will be an emergence of a market consensus on the mechanics of those rates, with new conventions emerging. Template documentation will be published by industry working groups (e.g. LMA or (in the US) ARRC) to reflect that market consensus that will be ready for use in deals. In the meantime, loan industry bodies have, and will continue to, publish consultation drafts for market participants to consider, and will publish the outcomes of those consultations.

When central clearing houses move to SOFR discounting in October 2020, this may provide more liquidity in the market place. Subject to the impacts of the COVID-19 pandemic, the UK regulator is pushing for the end of GBP LIBOR product selling/origination by Q3 2020. This timing may change.

2020 will be a critical year for the transition, during which market conventions are expected to be established, infrastructure/systems upgraded and documentation to be published that will assist with the contractual aspects of the move away from IBOR rates.

Following that, and particularly from Q1 2021, ANZ anticipates that the momentum in the transition will pick up significantly.

Moving too early or too late comes with associated risks and costs. Ideally to switch to RFR, you would want to have:

• sufficient liquidity in the RFR
• a system to calculate daily compounded RFR
• legal agreements with the relevant mechanics for calculating RFRs and robust fallbacks

Currently, there are a number of outstanding industry issues that need to be resolved. Monitoring these issues for resolution and waiting for optimal liquidity conditions may be the be course of action. Early communication of your preparedness with ANZ will allow for more efficient transitioning.