LIBOR Transition Background

What is IBOR?

Interbank Offered Rates (IBORs) are the average rates at which banks can borrow in the interbank market and range in maturities from overnight to 12 months. The rates are calculated using submissions from a number of panel banks.

What is LIBOR?

The London Interbank Offered Rate (LIBOR) is the most commonly used IBOR. It is an unsecured interbank borrowing rate. LIBOR is not set by supply and demand, nor is it set by the market or the government. Instead, it relies on the banks involved to accurately report the interest rates they would have to pay to borrow from each other. LIBOR is based on five currencies (US Dollar, European Euro, British Pound Sterling, Japanese Yen, and Swiss Franc) and seven different maturities (overnight/spot next, one week, and one, two, three, six, and twelve months). The combination of the five currencies and seven maturities creates a total of 35 different LIBOR rates that are calculated and reported each business day. The official LIBOR interest rates are published at 11:55 a.m. London time by the ICE Benchmark Administration (IBA).1

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How are LIBOR rates used?

As of mid-2018, about USD $400 trillion worth of global financial products are tied to LIBOR.2 LIBOR is widely used as a reference rate by market participants across nearly all asset classes, including: derivatives, bonds, loans, and other financial instruments. Some of these financial products are further detailed below:

  • Loans: Commercial products like syndicated loans, business loans, floating/variable rate notes, and variable rate mortgages, as well as consumer loan-related products like individual mortgages and student loans.

  • Derivatives: Forward rate agreements (FRAs), interest rate swaps, cross-currency swaps, interest rate futures/options, swaptions.

  • Bonds & Securities: A wide variety of accrual notes, callable notes, and perpetual notes, floating rate notes (FRNs) and securities like collateralized debt obligations (CDOs), and collateralized mortgage obligations (CMOs).

Why LIBOR rates are changing

In July 2017, the UK's Financial Conduct Authority (FCA) announced that it will no longer compel LIBOR panel member banks to contribute to the benchmark after 2021. While LIBOR may still be published for some time beyond 2021, the production of LIBOR is not guaranteed. Regulators have indicated a desire to move away from LIBOR and move towards alternative reference rates because LIBOR no longer fits its purpose. Due to changes in the regulatory framework, there has been a significant decline in the interbank unsecured funding markets in the last decade. Stringent liquidity rules since the 2008 financial crisis have made it far less attractive for banks to lend to other banks through short-term unsecured markets. Consider the three-month USD LIBOR rate – the most heavily referenced rate, which has a daily unsecured funding volume of around US$ 500 million but underpins over US$ 200 trillion in outstanding USD LIBOR based contracts.3 Given the limited activity in the unsecured lending market, LIBOR submissions are becoming more of a judgment call and thus there are increasing concerns about LIBOR’s long-term sustainability.

To improve durability, robustness, and sustainability of the underlying interest rate benchmark, regulators are encouraging the industry to move to alternative rates: rates that are lower risk and based on transactional data.

What is the timeline for LIBOR cessation?

The IBA, FCA, as well as the Financial Stability Board (FSB) have each released statements confirming that the transition from LIBOR remains a key priority and that firms cannot rely on LIBOR being published beyond 2021 (all non-USD LIBOR settings; USD LIBOR settings on 1W and 2M) and beyond June 2023 (remaining USD LIBOR settings). CIBC is following this guidance and, as such, continues to advance its LIBOR Transition Program efforts.

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What happens when LIBOR ceases to be reported?

Most contract documents that reference LIBOR contemplate a temporary cessation of a benchmark rate and not a permanent cessation. Therefore, an amendment of the embedded LIBOR fallback language in those documents is needed. In the case of derivatives, the International Swaps and Derivatives Association (ISDA) has published the IBOR Fallbacks Supplement (“Supplement”) which will amend the standard definitions for interest rate derivatives to include robust fallbacks. As of January 25, 2021, all new derivatives that reference the definitions will now include fallbacks. For legacy derivatives, parties will either need to amend their existing Master Agreements or adhere to ISDA’s 2020 IBOR Fallbacks Protocol (“Protocol”) which will incorporate fallbacks into legacy derivatives with other counterparties that choose to adhere to the Protocol. Loan documents are typically not standardized and thus each loan agreement will need to be negotiated and amended by the parties. However, there is standard loan fallback language that has been developed in most local jurisdictions that can be leveraged to address the LIBOR transition.