LIBOR (London Interbank Offer Rate) is currently calculated every business day for 35 types in 5 currencies and 7 tenors. Rates are calculated based on offered Rate by `Reference Banks` every London business day. As shown in the figure below, LIBOR is used for huge financial transactions such as bonds, loans and derivatives, so the abolition of LIBOR will have a great impact on economic activities.
|EUR + EURIBOR||$152 Trillion|
|JPY Interest Rate Swap||￥2,453Trillion|
|JPY Currency Swap||￥305Trillion|
As mentioned previously, LIBOR is not based upon actual deal. Furthermore, Reference Banks doesn’t have any obilgation of dea l on the referencerate that the bank estimated. In 2005 2009, several traders at Reference Banks had manipulated the reference rate for the purpos e of their profit andthis scandal came to light in 2012. As LIBOR is based upon the reference rates, LIBOR was raised doubts as to whether LIBOR has reliability,robustness, and fairness.
Following the discovery of LIBOR scandal, the International Organization of Securities Commissions (IOSCO) published the "Report on the Collection of Principles on Financial Indicators" in July 2013. The content is mainly related to the indicator calculator, but it also has an indirect effect on the data provider, such as the indicator calculator supervising the data provider and requesting the data provider to formulate the Code of Conduct. .. Then, in July 2014, the Financial Stability Board (FSB) published "Reforms of Major Interest Rate Indicators."
In July 2017 amid LIBOR reforming, Andrew Bailey, former head of Financial conduct Authority (Current Governor of BoE), announced FSA will not force reference banks to submit Reference Rate of LIBOR after 2021. This announcement triggered off increasing probability of LI BOR ceasing and each country started to prepare for LIBOR transition.
|Indentified Risk-Free Rate (RFR)||SOFR Secured Overnight Financing Rate||SAON Swiss Average Rate Overnight||SONIA Sterling Overnight Index Average||ESTR Euro Short-Term Rate||TONA Tokyo Overnight Average Rate|
|Collateralized / Uncollateralized||collateralized||Non-collateralized|
|Alternative Term Structured Rate of LIBOR||Term Rate based upon SOFR||Term Rate compound in arrears fixing based upon SARON||Term Rate based upon SONIA||Term Rate based upon ESTR / EURIBOR||TORF = Term Rate based upon TONA / TIBOR|
|Multiple Rate Approach or NOT||Only RFR (NOT)||RFR and IBORs|
As mentioned above, if LIBOR ceased while LIBOR referencing contract continues, Fallbacks process will be required. We explain here fallbacks triggers, fallbacks implementation procedures, and spread adjustment.
Given that Fallbacks are in case of LIBOR ceasing, it is necessary to set a Fallbacks triggers that initiate the transition from LIBOR to a new reference rate. Currently, ISDA expects the following examples of triggers
・The final publishing date for all JPY, CHF, EUR, GBP LIBOR and 1week / 2M USD LIBOR is 31st December 2021.
・The final publishing date for O/N, 3M, 6M, and 12M USD LIBOR is 30th June 2023.
・All LIBOR except USD LIBOR will become unrepresentative from 1s January 2022, and USD LIBOR will become unrepresentative from 1st July 2023 (Index Cessation Effective Date).
・Spread adjustment rates for all LIBOR fallbacks were fixed on 5th March 2021 (Spread Adjustment Date).
Fallbacks implementation procedures are different between transactions or contracts. However, ISDA will introduce a standardi zed fallbacks articles for existing contracts. The following methods are proposed for determining the Successor Rate
Hard wire approach・・Determine the Successor Rate (Fallbacks Rate + spread) when counterparty agree to the fallbacks article.
Corrective approach・・Determine the successor interest rate and how to activate the trigger. There are also measures such as entrusting the decision t o an independent advisor.
In order to do Fallbacks smoothly, it is necessary to develop the Fallbacks rates that based upon the term RFR.However, as mentioned before, there is a spread between LIBOR and RFR because RFR doesn’t include credit and liquidity risk premium.Therefore, if the Fallbacks rate is set to the Successor rate without adjustment, transfer of value (profit / loss) will occur. It is necessary to adjust the spread to minimize the transfer of value. (Note that it is not possible to completely prevent transfer of value by ad justing the spread.) The following is the formula of Successor rate
Fallbacks rate is selected from some options. Regarding spread adjustment method, there are several options: Forward approach Average and median approach of actual values, and Spot approach.
Method calculated based on the interest rate difference between the forward rate of LIBOR and the Fallbacks rate at the time of Fallbacks
Method of calculating based on the mean or median of the difference between LIBOR and Fallbacks rate over the past period
Method of calculating based on the difference between LIBOR and Fallbacks rate at Fallbacks
For ISDA derivatives, Bloomberg was elected as the fallback calculator, and the medium spread data forpast five years isused for calculation. Refer to FBAK & ISDA on Bloomberg. The fallback spread adjustment rates for ISDA derivatives fixed by the trigger activation on 5th March 2021. Following are the spread adjustment rates.
|Currency||Tenor||Spread Adjustment %||Ticker|