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
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.
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.
CIBC has mobilized a comprehensive Enterprise-wide IBOR Transition Program which addresses every aspect of the benchmark reform globally. The key work streams that run through all business units and infrastructure groups have been identified and are focused on areas such as communication, operational readiness, and product strategy and transition management.
The discontinuance of LIBOR may affect products and services that you have previously purchased or entered into and it is not yet clear how alternative reference rates will apply to any such products and services. You should consult with your own financial legal advisors on the possible effects of LIBOR reform. CIBC will continue to monitor the market and communicate updates taking place during the transition away from LIBOR.
What are the LIBOR alternative replacement rates?
Regulators around the world have tasked committees comprised of market participants to identify and recommend a successor rate in each country. These successor rates are outlined below.
Country | IBOR | Cessation Date | Alternative rate | Target Date to cease use of LIBOR |
USA | USD LIBOR | Dec 31, 2021 (USD LIBOR settings on 1W and 2M) June 30, 2023 (remaining USD LIBOR settings) |
SOFR (Secured Overnight Financing Rate) | Dec 31, 2021 |
UK | GBP LIBOR | Dec 31, 2021 | SONIA (Sterling Overnight Interbank Average Rate) | March 31, 2021 |
Europe | EUR LIBOR / EONIA | Dec 31, 2021 | €STR (Euro Short Term Rate) | Guidance not provided by industry bodies. |
Switzerland | CHF LIBOR | Dec 31, 2021 | SARON (Swiss Average Rate Overnight) | Guidance not provided by industry bodies. |
Japan | JPY LIBOR | Dec 31, 2021 | TONA (Tokyo Overnight Average Rate) | Guidance not provided by industry bodies. |
In Canada, the Canadian Alternative Reference Rate (CARR) working group selected the Canadian Overnight Repo Rate Average (CORRA) as the risk-free alternative to CDOR. CORRA is an existing Canadian overnight risk-free rate that is transaction-based and has been published since 1997. The Bank expects that, over time, CORRA will be adopted across a wider range of financial products and could become the dominant Canadian interest rate benchmark, particularly in derivatives markets. 4
IBORs in other jurisdictions – BBSW (Australia), Euribor (Europe), HIBOR (Hong Kong), TIBOR (Japan), and Fed Funds (US) – are also expected to continue post 2021.
What are the key differences between LIBOR and Risk-Free Rates (RFRs)?5
Criteria | LIBOR | SOFR | SONIA | €STR | SARON | TONA |
Transaction |
No – bank submission based on expert judgement (Unsecured) |
Yes – Repo transactions (Secured) |
Yes – Money Markets (Unsecured) |
Yes – Money Markets (Unsecured) |
Yes – Repo transactions (Secured) |
Yes – Money Markets (Unsecured) |
Term Structure |
Yes – 4 maturity tenors (Forward- looking) |
No – Overnight rate (Backward- looking) |
No – Overnight rate (Backward- looking) |
No – Overnight rate (Backward- looking) |
No – Overnight rate (Backward- looking) |
No – Overnight rate (Backward- looking) |
Includes |
Yes – Bank lending rate (includes credit risk) |
RFR (no credit risk) |
RFR (minimal/no credit risk) |
RFR (minimal/ no credit risk) |
RFR (no credit risk) |
RFR (minimal/ no credit risk) |
How would interest rates be calculated in the absence of forward-looking term structures?
Using backward-looking RFRs, a simple or compounded interest rate can be calculated. Under a simple interest calculation, the additional amount of interest owed each day is calculated by applying the daily rate of interest to the principal borrowed with the payment due at the end of the period being the sum of those payments. Under a compound interest calculation, the additional amount of interest owed each day is calculated by applying the daily rate of interest to both the principal borrowed and the accumulated unpaid interest. Market participants may also use this concept, both in arrears or in advance, to price financial instruments.
What is the convention for calculating the interest rate using alternative reference RFRs?
For derivatives, ISDA will use a compounded setting in arrears rate with a two-banking-day backward shift adjustment period. In the lending market, conventions are slightly different:
- UK lending market convention: SONIA loans to be booked via a compounded in arrears methodology and using a five-banking-day lookback.
- US market convention: The conventions have not standardized yet. SOFR loans may be booked via a simple average in arrears or compounded in arrears methodology, and a term rate is under development.
What are some of the key challenges market participants would likely face during and post transition?
- Lack of forward-looking term structure in RFRs: Unlike LIBOR, which has a term component for setting interest rates one, three, six or 12 months out, the new RFRs are backward-looking; therefore, systems, models and curves would be required to calculate compounded interest in arrears. Also, clients will not know the interest rate in advance of payment.
- Lack of credit risk in RFRs: Overnight RFRs would be lower than LIBOR rates; therefore, a spread would need to be added to ensure economic indifference as we transition from LIBOR rates to RFRs. Also, overnight RFRs have shown to be volatile at quarter-end and year-end.
- Lack of RFR market liquidity: Currently, there is not sufficient liquidity in RFR financial instruments as the volume of transactions referencing the new RFRs remains low, leading to less incentive to transition existing IBOR portfolios to RFRs. 6
- Multi-currency products: Where market conventions for alternative reference rates in a relevant currency are yet to be settled, parties should assess whether successive amendments to their multi-currency agreements will be required and whether the same or different pricing should apply to the various currencies.
Is there any progress with regard to the development of forward-looking RFRs?
In the UK, the IBA and Refinitiv each launched their respective Term SONIA benchmarks. Both benchmarks are available in 1-month, 3-month, 6-month and 12-month tenors. However, regulators recommend that the use of SONIA Term Rate be limited to select products (i.e., trade finance which require a term rate from a pricing perspective) and client types (i.e., smaller corporate, wealth and retail clients for whom simplicity and/or payment certainty is a key factor). BoE SONIA Use Case Consultation
In the US, the Alternative Reference Rate Committee (ARRC) is looking to select a benchmark administrator to develop a robust, IOSCO-compliant, forward-looking SOFR term rate that could be used in commercial contracts. ARRC’s intention was for such a rate to be available in the first half of 2021, but its availability is dependent on the growth and depth of SOFR derivatives markets. ARRC SOFR Term Rate Administrator RFP
What is the ISDA credit spread adjustment for legacy derivatives products?
As a risk-free (or near risk free) rate, RFRs will be lower than LIBOR. This necessitates a spread adjustment to compensate for the lack of credit and term risk in RFRs and help to economically neutralize the transition from LIBOR as much as possible. After extensive consultation, ISDA has recommended the use of a consistent approach to calculate and apply a spread adjustment when transitioning LIBOR products to RFRs. Credit spread adjustments will be based on a historical median over a five-year period, calculating the difference between LIBOR and respective RFRs. On March 5, 2021, the FCA announced that LIBOR will be discontinued and the spread adjustment became fixed from that day onwards. Bloomberg Index Services Limited (“Bloomberg”) is the official source for these fixed credit spread adjustments for derivatives. ARRC and the Bank of England Sterling RFR Working Group have agreed to match the value of ISDA’s spread adjustments when transitioning LIBOR lending products to RFRs.
What is the current spread adjustment between LIBOR and RFRs?
The spread adjustments between LIBORs and RFRs have now been fixed on a permanent basis and are available through Bloomberg for derivatives and Refinitiv for loans. Bloomberg LIBOR/ RFR Spread Adjustment Values; ARRC Announces Refinitiv as Spread Adjustment Publisher
Is there any progress with regard to the development of an RFR dynamic credit spread?
In the US, Bloomberg and IHS Markit are planning to publish a daily USD credit spread adjustment for SOFR loans to address the concern that, while LIBOR embeds a bank credit component, SOFR does not have a credit component as it is based on secured repo transactions. In times of market distress, USD LIBOR will tend to widen whereas SOFR will tighten without a credit spread adjustment. This credit risk component must also move in line with market dynamics so that credit exposures are properly captured in financial instruments over time. However, it is unclear at this time whether the market will adopt an RFR dynamic credit spread if it is developed. BLOOMBERG & IHS Markit join race for sofr credit add on
Is there any source to track development of RFR liquidity?
ISDA publishes RFR trading data on a monthly basis. As of January 2021, 10% of traded interest rate derivatives was based on RFRs. While the number of RFR-linked products has been increasing over the past few quarters, adoption is still quite low. Data can be accessed here: ISDA IRD RFR Data
The Loan Market Association (LMA) has been tracking RFR referencing syndicated and bilateral loans. To date, there have been very few loans executed which reference RFRs. The current list can be viewed here: RFR Loans Tracker
How will contractual rates change when they are based on RFRs as opposed to LIBOR?
There are inherent structural differences between LIBOR and RFRs. As mentioned, adjustments are needed to the RFRs to ensure that contracts which reference a LIBOR continue to meet the parties’ original objectives as much as possible once a fallback takes effect. For loan products, the recommended approach for the spread adjustment is based on the historical median over a five-year period that calculates the differences between the relevant LIBOR setting and the relevant RFR compounded over each corresponding period. Alternatively, loans could use methodologies based on simple averages and calculate payments using forward-looking conventions once they are available. While the economics of RFR transactions will be similar to those under the existing LIBOR product, it is impossible to say on any particular day that they will be identical.
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Regulators and industry bodies have been working together to deliver on the following
milestones:- LIBOR Cessation Trigger:
On March 5, 2021, the FCA announced the dates that panel bank submissions for all LIBOR
settings will cease, after which representative LIBOR rates will no longer be available.
FCA LIBOR Cessation Timelines Announcement.
- All LIBOR settings will either cease to be provided by any administrator or no
longer be representative:- Immediately after December 31, 2021 in the case of all sterling (GBP), euro
(EUR), Swiss franc (CHF) and Japanese yen (JPY) settings, as well as the
1-week and 2-month US dollar (USD) settings; and - Immediately after June 30, 2023 in the case of the remaining USD settings.
- IBA confirmed its intention to cease publication for all LIBOR settings in
accordance with the FCA dates above based on the feedback IBA received from
its December 2020 consultation. IBA release:
IBA LIBOR Cessation Consultation. - ISDA has stated that the FCA’s LIBOR cessation announcement constitutes an
“Index Cessation Event” under the IBOR Fallbacks Supplement and the ISDA
2020 IBOR Fallbacks Protocol for all 35 LIBOR settings.
ISDA LIBOR Cessation Announcement. - The FCA and IBA announcements constitute a “Benchmark Transition Event” as
defined in ARRC fallback language and a “Rate Switch Trigger Event” as
defined in the LMA Rate Switch Agreement.
ARRC Confirms a “Benchmark Transition Event” has occurred under ARRC Fallback Language;
LMA Rate Switch Provisions in Credit Agreements
- Immediately after December 31, 2021 in the case of all sterling (GBP), euro
- All LIBOR settings will either cease to be provided by any administrator or no
- Derivatives:
ISDA has published its 2020 IBOR Fallbacks Protocol and a related Supplement to the 2006
ISDA Definitions. The Supplement became effective on January 25, 2021 and amends the 2006
Definitions to provide a LIBOR fallback mechanism for new derivatives transactions that
incorporate the 2006 Definitions. The Protocol provides a uniform market-wide mechanism for
parties to voluntarily amend existing derivatives contracts to address LIBOR
discontinuation.- The Protocol can be viewed here:
ISDA Fallback Protocols & Supplement - Sign up for the Protocol here:
ISDA Fallback Protocol
- Industry stance:
The relevant industry bodies – ISDA, ARRC, the FSB, as well as
various central banks, tax authorities and accounting boards strongly encourage
widespread and early adherence to the Protocol by all affected financial and
non-financial firms. As of today, more than 13,500 firms have signed the Protocol.
List of ISDA Protocol Adhering Parties
- Derivatives Product Transition Guidance:
ISDA has provided details on how fallbacks would function for various derivatives
products.
RFR Conventions and IBOR Fallback Product Table (including guidance on how
fallbacks operate for non-linear derivatives)
- CIBC’s decision:
After reviewing the details of the Protocol with our internal financial and legal
advisors, we have decided to adhere to the Protocol and have submitted our decision
to ISDA. - Action recommended:
CIBC recommends that you review the details of the Protocol with your professional
advisors and take the course of action that best suits your requirements. For
clients that elect to not adhere to the Protocol, the parties will need to negotiate
a bilateral amendment to their agreement prior to the cessation date. - Central Counterparty Clearing Houses (CCPs) approach to converting swaps from
LIBOR to RFR.
CCPs, such as London Clearing House (LCH) and Chicago Mercantile Exchange (CME),
plan to convert LIBOR swaps to RFRs before the cessation dates mentioned above. CCPs
will provide more details in the coming weeks and months.
Early Libor Shift for Derivatives Is Weighed by Clearing Houses.
As a reminder, LCH/ CME completed the switch of discounting from Fed Funds to SOFR
CCP Discounting Switch. CCP Discounting Switch.
CCPs complete discounting switch
- The Protocol can be viewed here:
- Lending Products:
The ARRC and LMA have each published updated versions of their recommended fallback language
for USD and GBP LIBOR-denominated syndicated and bilateral business loans.- The documents can be viewed here:
Alternative Reference Rate Committee Announcements;
LMA RFR Loan Documentation
- Key recommendations: ARRC recommends the adoption of hardwired fallback
language in lending product contracts (loans, bonds, securitizations) as it offers
certainty over the replacement rate and spread and likely eliminates the need
to amend the loan at the time of the LIBOR transition. In September 2020, the
LMA published an exposure draft of a multicurrency term and revolving facility
agreement with a mechanism to switch from LIBOR to compounded RFRs at a
specified date during the term of the facility. - Spread adjustment: The industry recommended methodology is based on a
historical median over a five-year lookback period calculating the difference
between USD LIBOR and SOFR. This is the same approach used by ISDA for
derivatives products. As of March 5, 2021, this spread is now fixed. - Interest rate calculation convention: In the UK, the recommendation is to use a
compounded in arrears with a five-day lookback methodology. However, in the
US, there are a number of conventions and the market has not yet settled on
any one standard. The ARRC recommends a waterfall mechanism, which allows
the counterparties to use any of the following conventions: a) Term SOFR, b)
Simple Average SOFR in arrears, c) Compounded in Arrears SOFR, or that b) or
c) be used if Term SOFR is not yet available. - Impact on hedging: Transition activities may have an adverse impact on the
effectiveness of derivatives trades that are used as cashflow hedges. If the
timing of the fallback trigger in each product differs, this could result in the
derivative no longer being an effective hedge for the underlying loan. - Action recommended: CIBC recommends that you review the details of the
ARRC and LMA fallback language to fully understand the impact on your
business from a commercial, legal and operational standpoint. We also
recommend (in the case of hedged loans) that you review and amend both the
loan and swap contracts at the same time to avoid potential basis mismatches.
CIBC will contact you in due course to review our mutual contracts and update
them to meet industry best practices.
- The documents can be viewed here:
- LIBOR/ RFR Spread adjustment methodology:
Regulators have confirmed the “historical median approach” as the recommended fallback
spread adjustment methodology for lending and derivatives products. It is based on the
median spot spread between the LIBOR and the adjusted RFR calculated over a five-year
lookback period prior to the relevant cessation announcement. The fallback rate will equal
the term-adjusted RFR plus the spread adjustment. Bloomberg has been selected by ISDA
to calculate and publish the fallback rates in derivatives products on a delayed basis.
Bloomberg Fallback Rates
- Synthetic LIBOR rates:
The FCA now has the power to compel the publication of a
benchmark for up to 10 years and impose new methodology requirements on IBA to
keep a synthetic version available. The FCA will consult on whether to require IBA to
continue publishing GBP and JPY on a ‘synthetic’ basis. For JPY, the FCA would only
compel publication for one additional year—until December 31, 2022. The FCA will
continue to monitor progress made to transition away from USD LIBOR in order to
determine if a synthetic rate for 1m, 3m or 6m USD LIBOR would be viable and
necessary. The FCA has indicated that a synthetic rate would equal a term RFR plus
the ISDA fallback spread adjustment. Regulators have advised that these synthetic
forms of LIBOR should only be used for “tough legacy” contracts which cannot be
amended before LIBOR discontinuation timelines.
FCA Announcement on the end of LIBOR
- Accounting guidance:
International Accounting Standards Board (IASB) has finalized
International Financial Reporting Standards (IFRS) guidelines to deal with accounting
issues arising from the replacement of LIBOR, including hedge accounting issues.
International Accounting Standards Body (IASB) LIBOR Transition Guidance
- Tax guidance:
U.S. Internal Revenue Service (IRS) has provided interim guidance on transitioning away from
LIBOR to RFR.
Internal Revenue Service (IRS) LIBOR Transition Guidance
- LIBOR Cessation Trigger:
CIBC is actively engaging with industry bodies and market participants to support a smooth transition away from LIBOR. Internally, CIBC has put into place a comprehensive LIBOR Transition Program that covers all aspects of the transition, including client communication, contract digitization & remediation, operational readiness, product transition strategy, risk management and financial controls.
We would recommend that you review your firm’s LIBOR exposures, as well as contracts with LIBOR reference, and work with your independent financial and legal advisors to ensure you are ready for the transition event. You should also ensure your systems, models and processes are updated to handle the alternative RFRs. Finally, as there is still some uncertainty around the transition, as highlighted above, we recommend that you continue to closely monitor market developments. CIBC will make every effort to inform you of any significant market developments.
If you have any questions, please contact us at mailbox.ibor@cibc.com.
For Bank USA questions related to the LIBOR transition, please contact us at Mailbox.USLibor@cibc.com.
The following table provides additional resources for information about the transition.
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