Interest rate Benchmarks are widely used in many financial contracts and products. The London Interbank Offered Rate (“LIBOR"), Euro Overnight Index Average (“EONIA") and other Interbank Offered Rates (“IBORs") have been among the most used benchmark rates in the financial sector but in recent years have been subject to increasing global regulatory scrutiny, with regulators mandating the need to use alternative rates such as “risk free rates" (“RFRs").
On the 5 March 2021 the UK Financial Conduct Authority (FCA) announced the dates of permanent cessation or loss of representativeness for 35 LIBOR settings. All parties to financial products or contracts referencing LIBOR will need to take action to transition to alternatives, with the following milestone dates applying:
Immediately after 31 December 2021
- Euro LIBOR: all seven settings will cease publication
- Swiss franc LIBOR: all seven settings will cease publication
- Japanese yen LIBOR: Spot Next, 1-week, 2-month and 12-month settings will cease publication; 1-month, 3-month and 6-month settings will no longer be representative and representativeness will not be restored
- Sterling LIBOR: overnight, 1-week, 2-month and 12-month settings will cease publication; 1-month, 3-month and 6-month settings will no longer be representative and representativeness will not be restored
- US Dollar LIBOR: 1-week and 2-month settings will cease publication
Immediately after 30 June 2023
- US Dollar LIBOR: overnight and 12-month US dollar LIBOR settings will cease publication; 1-month, 3-month and 6-month settings will no longer be representative and representativeness will not be restored
The FCA has also confirmed it is requiring the publication of 1, 3, and 6-month LIBOR rates for sterling and Japanese yen on a changed methodology (also known as a “synthetic") basis until the end of 2022 to allow more time to complete transition. The FCA will allow the temporary use of 'synthetic' sterling and yen LIBOR rates in all legacy LIBOR contracts, other than cleared derivatives, that have not been transitioned before end 2021. These synthetic rates will not be available for use in any new contracts.
In addition, the European Money Markets Institute (EMMI) has announced that the EONIA rate will be discontinued as an interest rate benchmark from 3 January 2022.
You should be aware that industry working groups including the Working Group on Sterling Risk-Free Reference Rates (information can be found here) and the US Alternative Reference Rates Committee (ARRC) (here) have recommended a number of target dates to include robust contractual fallback language or cease new LIBOR-linked business. Other local regulators and / or groups may have also published similar recommendations for other currencies and / or rates.
US and UK regulators have also stated firms should cease entering into contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by 31 December 2021. The use of USD LIBOR from 1st January 2022 should only be used in accordance with the exception use cases outlined by regulators. UK supervised institutions should also be aware of the formal prohibition on the use of the remaining USD LIBOR tenors in new deals under UK regulatory rules. Additional information on the prohibitions and exceptions outlined by the US regulators can be found here. Details on the UK FCA statement can be found here.
What you need to know about contracts referencing a Benchmark that is subject to reform or cessation:
Parties entering into transactions that continue to use Benchmarks subject to reform or cessation (also known as “demising Benchmarks") may be exposed to certain risks including:
- Financial contracts and confirmations are likely to require amendments ahead of cessation or reform to ensure products perform as expected. Although some products will contain fallback provisions if a relevant Benchmark ceases, these may not provide a long-term solution and may differ across products. Some products may not include fallback provisions at all or provide discretion to one party in a transaction.
- One or more Benchmarks may perform differently than in the past, and financial products referencing existing Benchmarks scheduled to be discontinued may perform differently as a result. For example, the Benchmarks may be higher, lower or more volatile than in the past. This means you may be paying more or receiving less than you otherwise would have expected. Additionally, the value of the product may alter as a result of the change to a Benchmark, and the product may be worth more or less than it would have if the Benchmark had continued to be available.
- There may be a mismatch between the rates in commercially-linked products (e.g. where a derivative is intended to operate as a hedge to a loan or bond), particularly if reference rates or fallback provisions are not aligned between commercially-linked positions. There may be differences in methods of calculations or conventions used for alternative reference rates across the market. This means that payments and valuation in respect of similar financial products or linked financial products may be different.
- Operational and other challenges may arise in the event of Benchmark cessation (e.g. where systems need to be updated to support alternative rates).
Please note this is not an exhaustive list of risks, and you should consider other risks that could arise with respect to your business. These risks may also be applicable to other Benchmarks which are subject to discontinuation or Benchmarks which use LIBOR as input into their calculation.
What you need to know about contracts referencing new or alternative Risk Free Rate Benchmarks:
RFRs are different to LIBOR both structurally and economically. LIBOR is forward-looking and reflects the rate banks would charge other banks to borrow on an unsecured basis for various periods (called tenors). A LIBOR rate includes a measure of bank credit risk, and a term liquidity premium based on the length of the tenor. RFRs are backward-looking and are based on overnight rates actually charged on a pool of virtually risk-free investments. They reflect the characteristics of the underlying local market, and they do not compensate lenders for making longer-term funds available nor compensate for bank credit risk. Some pre-existing instruments and contracts transitioning from IBOR to RFR reference rates may incorporate a credit adjustment spread to account for the economic differences between the two rates.
Market conventions for products linked to alternative rates and associated credit spread adjustments may change over time. You should carefully consider the risks and benefits of using one replacement rate over another.
MUFG is actively working on transition away from LIBOR. If you wish to obtain further information, enquiries can be made to firstname.lastname@example.org (MUFG Bank) or email@example.com (MUFG Securities) or visit our website at LIBOR.
NOTE that we are not providing you with any advice and you should consult your own advisors for advice on the reform of Benchmarks and the related risks. We make no representation and provide no warranty as to the information set out in herein, which is based on information from third parties, and you should not rely on any such information as constituting a representation or warranty. The content herein is not intended to be comprehensive and was last updated in April 2021. Material developments may have occurred since this last update. The information herein does not consider risks to you from interest rate reform and there may be other issues that are not highlighted above. Without limiting the foregoing, information herein does not address issues specific to any particular sector or business. We are not acting as your fiduciary or adviser and the provision of this information to you will not give rise to any duty of care. We assume no responsibility for any use to which this information is put. The areas covered herein are continually evolving and you should consult the relevant sources.