The transition from Interbank Offered Rates (IBOR) to Alternative Risk-Free Rates (RFRs) has an impact on all financial and non-financial institutions operating with the impacted floating reference rates. It affects a wide range of financial instruments on the derivative and cash markets.

This blog edition highlights notable developments made publicly available by the global regulatory community, industry working groups and/or infrastructure providers over the month of May 2021. You will find more detail in our monthly EY IBOR Transition Newsletter, to which you may subscribe through the following link.

During the past month, efforts have continued to be made by working groups to enable market participants to get ready for the fast approaching IBOR cessation.

Recently, the International Swaps and Derivatives Association (ISDA) published supplements 74, 75 and 76 to 2006 ISDA Definitions: 

  • Supplement 74: this supplement adds floating rate options for overnight versions of main RFRs which can be used with various compounding and averaging approaches.
  • Supplement 75: this supplement includes the provisions that are required to be able to implement the compounding / averaging approaches in confirmations.
  • Supplement 76: this supplement includes the provisions required to use indices that are published for specific RFRs in confirmation and a floating rate option for the SONIA index.

ISDA has also published a memorandum highlighting the different compounding and averaging approaches which enable firms to align with overnight rates that have been developed in cash markets.

Moreover, the Working Group on Euro Risk-Free Rates (EUR RFR WG) published its recommendations addressing events that would trigger fallbacks in EURIBOR-related contracts, as well as €STR-based EURIBOR fallback rates (rates that could be used if a fallback is triggered). While there is currently no plan to discontinue EURIBOR, the recommendations encourage the industry to adopt more robust fallback clauses, Indeed, the development of more robust fallback language addresses the risk of a potential permanent discontinuation and is in line with the EU Benchmarks Regulation (BMR). The recommendations provide guidance and represent general market consensus on EURIBOR and €STR-based fallback rates that market participants might wish to use in their contracts:

  • Contracts referencing EURIBOR should include provisions covering trigger events related to permanent cessation, temporary non-availability, and non-representativeness (pre-cessation);
  • Trigger events should be objectively drafted in precise terms, be consistent across all asset classes, and refer to publicly available events by the regulatory supervisor / administrator;
  • Consider at least those trigger events included in Article 23b(2) of the EU BMR.

Also worth being mentioned is the consultation released by ICE Benchmark Administration (IBA) which seeks to gather feedback on the planned cessation of GBP LIBOR ICE Swap Rate for all tenors immediately after publication at the end of 2021. IBA does not expect to be able to continue to publish GBP LIBOR ICE Swap rate settings after December 31, 2021, because IBA does not expect sufficient (or perhaps any) input data to be available based on eligible new interest rate swap transactions referencing GBP LIBOR settings from this time. The consultation includes questions around market participant’s views on the planned cessation, the proposed date as well as the USD LIBOR ICE Swap Rate cessation.

EY Perspectives

7 months ahead of the LIBOR cessation, the key areas of focus for the industry are: 

  • Slow USD transition due to lack of term rate and confusion around alternatives to SOFR 

There is an increasing number of financial institutions that are using alternative benchmarks, as opposed to SOFR and market watchers have noted that there is room for other rates, particularly ones that include a credit component, which SOFR lacks. BSBY is one of the contenders, including AMERIBOR and ICE’s Bank Yield Index. Adapting to this new reality, ISDA published supplements 72 and 73 to the 2006 ISDA Definitions to add rate options for AMERIBOR Term and Bloomberg Short-Term Bank Yield Index (BSBY), respectively. Indeed, ISDA has previously commented that “RFRs aren’t the only options out there” …” However, what is clear is that whichever option is chosen, market participants should not leave the switch until the last minute”.

The post-LIBOR world looks to be increasingly fractured as people attempt to identify rates which best suit their own individual needs. Dissatisfaction with SOFR – which lacks both a forward-looking rate and a credit component – has contributed to this situation. However, it is not to be assumed that the entire market and – crucially – market authorities and regulators feel the same way. Also, this poses additional issues as it adds a layer of complexity as well as slows the creation of liquidity in any one benchmark. For example, the Governor of the BoE, Andrew Bailey, recently warned that, “while these rates may offer convenience as a short-term substitution, they present a range of complex longer-term risks… veneer over the fundamental challenges of thin and incomplete markets through the extrapolation of data”. 

The announcement from ARRC on the selection of the CME Group as the recommended administrator for the forward looking secured SOFR term rate, once the market indicators have been met, will allow market participants to plan ahead. In the near future the ARRC plans to announce its final recommendation for a forward-looking SOFR rate, alongside with the best practices for the use of this rate (for limited use cases).

  • Operationalisation of fallbacks and the operational capacity to execute the “big bang” transition at the end of year 

While the “tough legacy legislation” should to some extent help to deal with the transition away from LIBOR and to reduce risk of the “big bang” transition, the market participants should be urged to seek legal advice as to whether and how their contracts are affected by the proposed legislations. 

The gradual and voluntary transition ahead of the LIBOR cessation date and without reliance of the contractual fallbacks in place is to be preferred as it provides a greater level of control over the transition conditions and reduces risk. 

 At this point, the benefit of transitioning directly has become obvious as opposed to amending the documentation with fallbacks.

Based on the adoption indicator, we are seeing a large increase in the adoption of RFR linked trading activity. This has increased significantly over the past few months showing that the contracts are beginning to reference alternative rates and transition away from LIBOR.

For more information on these topics, please contact us directly.

You will find below the list of key developments in the IBOR transition over the month of May 2021, the detail of which can be found in our monthly EY IBOR Transition Newsletter.

Swiss highlights:

  • Developmentof SARON
  • Maximum interest rate for consumer loans: SAR3MC confirmed as new reference interest rate as a basis for calculation
  • New Swiss banks offering SARON-based cash products

Eurozone specific highlights:

  • EUR RFR WG published recommendations on EURIBOR fallbacks

International highlights:

  • ISDA published Supplements 72 and 73 to the 2006 ISDA Definitions to add rate options for AMERIBOR and BSBY
  • ISDA published its April 2021 ISDA-Clarus RFR Adoption Indicator
  • ISDA published Supplements 74, 75 and 76 to the 2006 ISDA Definitions to add various compounding and averaging approaches
  • ICMA and Bloomberg published guide to tough legacy bonds in Asia-Pacific

UK specific highlights:

  • IBA published consultation on its intention to cease publication of ICE Swap Rate settings based on GBP LBOR
  • HM Treasury published outcome on its consultation “Supporting the wind-down of critical benchmarks”
  • HM Treasury Official issued response to letter from Chair of the GBP RFR WG
  • GBP RFR WG published April 2021 newsletter
  • Governor of BoE delivered speech “Descending safely: Life after LIBOR”
  • FCA and BoE encouraged market participants in a switch to SONIA in the sterling exchange traded derivatives from June 17, 2021
  • IBA launched GBP SONIA spread-adjusted ICE Swap Rate ‘beta’ settings
  • GBP RFR WG published statement on recommendation of successor rate for fallbacks in bond documentation referencing GBP LIBOR
  • FCA published consultation on proposed policy framework for exercising of its new powers under the BMR
  • LMA updated list of loans’ referencing risk-free rates
  • LMA published further RFR documentation to assist the market with LIBOR transition

US specific highlights:

  • ARRC published market indicators to support a recommendation of a forward-looking SOFR term rate
  • ARRC released guide to published SOFR averages
  • ARRC published update on its RFP process for selecting a forward-looking SOFR term rate administrator
  • CME Group announced launch of BSBY futures in Q3
  • ARRC announced third event in its series “The SOFR Symposium: The Final Year”
  • ARRC published April-May 2021 newsletter