LIBOR Cessation and the Impact on Fallbacks

ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.

It’s long been clear that LIBOR can’t be relied upon after the end of 2021, but today’s announcement by the UK Financial Conduct Authority (FCA) on LIBOR’s future will likely put a rocket on transition efforts. As well as giving firms a clear timetable for when they need to shift to alternative reference rates, the derivatives industry also now has clarity on exactly when new fallbacks for outstanding LIBOR exposures will kick in, as well as the spread adjustments that will be added to the adjusted risk-free rates (RFRs) in the fallback methodology.

The FCA announced the timing for the cessation or loss of representativeness of all 35 LIBOR settings at once, giving firms a clear set of deadlines across all currencies and tenors. Following a consultation by ICE Benchmark Administration (IBA), the administrator of LIBOR, the FCA confirmed that all seven tenors for both euro and Swiss franc LIBOR, overnight, one-week, two-month and 12-month sterling LIBOR, spot next, one-week, two-month and 12-month yen LIBOR and one-week and two-month US dollar LIBOR will permanently cease immediately after December 31, 2021. Publication of the overnight and 12-month US dollar LIBOR settings will cease for good immediately after June 30, 2023.

Furthermore, the UK regulator stated that it intends to consult on using proposed new powers under the Financial Services Bill to require IBA to continue publishing one-month, three-month and six-month sterling LIBOR on a synthetic basis for a further period after the end of 2021, and one-month, three-month and six-month yen LIBOR on a synthetic basis for an additional year after end-2021.

It will also consider whether to require IBA to continue publishing one-month, three-month and six-month US dollar LIBOR on a synthetic basis for a further period after the end of June 2023.

Importantly, the FCA confirmed these settings would no longer be representative of their underlying market after December 31, 2021 (for the six sterling and yen LIBOR tenors) and June 30, 2023 (for the three US dollar LIBOR tenors). It also stressed that use of synthetic LIBOR by UK regulated firms will not be permitted for new trades, while use by regulated firms in legacy transactions will be subject to permission from the FCA under its proposed new powers.

As well as providing clarity on the LIBOR timetable, the FCA statement represented an index cessation event under the IBOR Fallbacks Supplement and protocol, triggering a fixing of the fallback spread adjustment at the point of the announcement.

This spread adjustment is an important part of the overall fallback rate, and reflects a portion of the structural differences between interbank offered rates (IBORs) and the RFRs used as a basis for the fallbacks – IBORs incorporate a credit risk premium and other factors, while RFRs are risk free or nearly risk free. Following multiple industry consultations by ISDA, it was determined that the fallback for each IBOR setting will be based on the relevant RFR compounded in arrears to address differences in tenor, plus a spread adjustment to account for the credit risk premium and other factors, calculated using a historical median approach over a five-year lookback period from the date of an announcement on cessation or non-representativeness.

This spread has now been fixed for all euro, sterling, Swiss franc, US dollar and yen LIBOR tenors, giving firms more information about the exact fallback rate that will be used in the event they don’t complete their transition efforts before cessation or non-representativeness occurs.

While the LIBOR spread adjustments were fixed at the point of the FCA announcement, the fallbacks will apply when each LIBOR setting ceases or becomes non-representative – so, after December 31, 2021 for outstanding derivatives that continue to reference all euro, sterling, Swiss franc and yen LIBOR settings. However, there are some nuances for US dollar LIBOR.

All US dollar LIBOR settings will continue to be published until the end of 2021. After that point, one-week and two-month US dollar LIBOR will cease, but the new fallbacks will not immediately take effect. Instead, the rate for the one-week and two-month US dollar LIBOR settings will be computed by each calculation agent using linear interpolation between the next shorter and next longer tenors that continue to be published. The fallbacks for all US dollar LIBOR settings will then apply after the end of June 2023, when the remaining US dollar LIBOR tenors cease or become non-representative.

As US dollar LIBOR is a component in the calculation of the Singapore dollar Swap Offer Rate and the Thai Baht Interest Rate Fixing, fallbacks for these rates will also apply after June 30, 2023.

Now the deadlines and spread adjustments for the fallback rates are fixed, firms can push forward with their transition initiatives. With under 10 months to go until 24 LIBOR settings completely cease and another six become non-representative, there’s not much time left. One concrete step that firms can take to reduce the risk of disruption is to adhere to the ISDA 2020 IBOR Fallbacks Protocol. More than 13,000 firms already have, but for those that haven’t – the protocol remains open for adherence.

Read ISDA’s guidance statement on the FCA announcement here.

Read the Bloomberg technical announcement on the fixing of the spread adjustment here.

The IBOR Fallbacks Supplement is available here. The ISDA 2020 IBOR Fallbacks Protocol is available here.

ISDA is running a number of events on LIBOR transition and benchmark fallbacks:

Benchmarks Strategies Forum Asia Pacific: March 17 & 18

Benchmarks Strategies Forum Global: April 13

ISDA Annual General Meeting – Virtual: May 10, 11 & 12

For additional information on benchmark reform, visit ISDA’s benchmark reform and transition from LIBOR page on the ISDA website.


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