What is LIBOR?
For many years, the London Interbank Offered Rate (LIBOR) has been one of the most widely used interest rate benchmarks in the world. Launched in 1969, LIBOR was first used in the syndicated loan market as a way to spread the risk of a loan across multiple lenders, using a periodic reset in the rate based on the banks’ funding costs plus a spread for credit risk. Over the last 50 years, LIBOR has become the most widely used interest-rate benchmark in the world.
The ICE Benchmark Administration (IBA) has served as the benchmark administrator for LIBOR. For those LIBOR tenors still in publication (unless being maintained only on a synthetic basis), the rates are intended to indicate the average rates at which banks could obtain wholesale, unsecured funding and are calculated based on contributions from panels of banks, one panel for each currency. For USD LIBOR, the panel of banks includes Bank of America, N.A.’s London branch, among other major banks.
Why is LIBOR being discontinued?
Since the 2008 financial crisis, the robustness of LIBOR as a benchmark of banks funding costs has been called into question, leading to the creation of alternative reference rates (ARRs) in several of the major currencies to enable a transition away from LIBOR. The UK’s Financial Conduct Authority (FCA), which has supervisory oversight over the administration of LIBOR, announced in July 2017 that it would no longer compel LIBOR panel banks to submit rates for LIBOR after 2021.
What is the impact of LIBOR cessation and non-representativeness?
With respect to contracts or products that reference LIBOR, LIBOR cessation or non-representativeness may impact such contracts or products, including with respect to the fixing of certain spread adjustments and the date on which the replacement rate under such contract or product may become effective.
For derivatives and other relevant products and for all 35 LIBOR settings, (i) the FCA’s March 5, 2021 announcement on LIBOR cessation and non-representativeness constitutes an “Index Cessation Event” for the purposes of and as defined in each of the Attachment to the ISDA 2020 IBOR Fallbacks Protocol and Supplement 70 to the 2006 ISDA Definitions; and (ii) March 5, 2021 constitutes a “Spread Adjustment Fixing Date” under the Bloomberg IBOR Fallback Rate Adjustments Rule Book.
For the avoidance of doubt, each relevant LIBOR-linked contract and product may transition to a replacement rate (e.g., based on Secured Overnight Financing Rate [SOFR] or Sterling Overnight Interbank Average Rate [SONIA]) in accordance with the terms and fallback provisions (if any) contained therein, and publication of the announcement does not automatically transition such contracts and products to the replacement rate as of the date of the announcement. Also, circumstances could change that could impact the timing and other information described herein.
After December 31, 2021, the FCA chose to compel the IBA to publish the 1-month, 3-month, and 6-month GBP and JPY LIBOR settings on a non-representative, synthetic basis. Publication of all synthetic JPY LIBOR settings ceased after year-end 2022. The FCA has announced that publication of the 1-month and 6-month synthetic GBP LIBOR settings will cease after March 31, 2023, while publication of 3-month synthetic GBP LIBOR setting will cease after March 31, 2024. Further, the FCA has issued a consultation seeking views on whether it should compel publication of 1-month, 3-month, and 6-month USD LIBOR settings on a synthetic basis through September 30, 2024.
The methodology by which IBA is required to calculate these synthetic rates is as follows: the forward-looking term versions of the relevant risk-free rate (i.e., the ICE Term SONIA Reference Rates provided by IBA for GBP and, as proposed, the CME Term SOFR References Rates for USD), plus the respective ISDA fixed spread adjustment (as published for the purpose of ISDA’s IBOR Fallbacks for those settings).
The FCA has made it clear that the use of synthetic GBP LIBOR or, as proposed, synthetic USD LIBOR is only to assist holders of legacy contracts that are challenging to modify (often referred to as “tough legacy” contracts) in transitioning away from those settings.
Consistent with this and regulatory expectations more generally, Bank of America’s priority has been to focus on active transition away from LIBOR where possible, rather than relying on synthetic LIBOR. Further, the FCA’s authority to mandate publication of synthetic LIBOR is temporary. Accordingly, should a contract or product utilize synthetic GBP or USD LIBOR, such contract or product will still need to transition to an ARR.
Further, in the U.S., a federal law, the Adjustable Interest Rate (LIBOR) Act, was passed (and subsequently implemented by the Federal Reserve Board’s Regulation ZZ) to aid transition efforts with respect to U.S. law-governed tough legacy contracts through a statutory replacement of USD LIBOR to a SOFR-based replacement rate. The EU and the UK have adopted similar legislation. Bank of America continues to monitor such legislative developments.
What is LIBOR transitioning to?
The following chart provides ARRs that various working groups have identified and recommended across five major jurisdictions as alternatives to LIBOR.
