Libor Transition Background

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.

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

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.

• 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
  • 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
      
  • 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.
  • 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
    

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.