Impact of the IBA consultation and FCA announcement for financial institutions

The IBA also released the end dates for the following USD LIBOR tenors:

• December 31, 2021 — 1-week and 2-month USD LIBOR
• June 30, 2023 — Overnight, 1-month, 3-month, 6-month, and 12-month USD LIBOR

Extending certain LIBOR tenors to 2023 potentially allows some legacy contracts that cannot be easily amended to mature on their current terms. The FCA stated that, “Today’s announcements confirm the importance of those preparations for all users of LIBOR,” and that it has, “worked closely with market participants and regulatory authorities around the world to ensure that robust alternatives to LIBOR are available and that existing contracts can be transitioned onto these alternatives to safeguard financial stability and market integrity”.

According to the International Swaps and Derivatives Association (ISDA), who also released a statement today, the IBA’s announcement does constitute an Index Cessation Event for the purposes of the ISDA IBOR Fallbacks Supplement and the ISDA 2020 Fallbacks Protocol. We now know when to expect the Index Cessation Effective Date(s), and the 5-year historical median spread between LIBOR and the Secured Overnight Financing Rate (SOFR). As you may recall, ISDA had selected Bloomberg to calculate these spreads which were also released today.

If you have contracts that have successfully incorporated the ISDA IBOR Fallbacks Supplement through the scenarios listed below, then upon an Index Cessation Effective Date, your LIBOR trades will reference Fallback Rate (SOFR):

• Adhering to the ISDA IBOR Fallbacks Protocol
• Executing a new LIBOR transaction after January 25, 2021
• Bilaterally amending contracts to incorporate the fallback terms
• Being a counterparty to either the CME or LCH on LIBOR transactions

Effective July 1, 2023, a 1-month LIBOR trade will transition to Fallback Rate (SOFR) which will use the 5-year historical median spread between LIBOR and SOFR. Until July 1, 2023, 1-month LIBOR will continue to be published. For reference here are some other 5-year historical median spreads on other tenors of LIBOR that are now set:

• 1-month = 0.11448%
• 3-month = 0.26161%
• 6-month = 0.42826%

The Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (collectively, the “Agencies”) previously issued a statement in conjunction with the IBA’s consultation. Notwithstanding the extension of certain LIBOR tenors to 2023 (and with some narrowly defined exceptions), banks may no longer offer new LIBOR-based contracts as soon as practicable, but no later than December 31, 2021. Further, all new contracts referencing LIBOR shall contain unequivocal fallback language to mitigate safety and soundness risks related to the transition.

We do not view the IBA and FCA’s announcement as creating an immediate material impact on your financial institution’s existing processes and plans related to the cessation of LIBOR. We expect that there will be more of a focus toward preparing for the transition away from LIBOR on new contracts because of the IBA and FCA’s announcements, combined with the Agencies’ previous guidance.

Firms are continuing to lend, and hedge based on LIBOR but are slowly transitioning away from it. Many institutions are coordinating with their loan servicers, operational systems personnel, and internal LIBOR transition committees on viable alternatives (e.g., SOFR daily compounded in arrears, or daily weighted average SOFR). We will continue to monitor which fallback rate regional and community banks will switch to in accordance with the Agencies’ statement.

We anticipate the LIBOR transition process for our financial institution clients who centrally clear transactions with the CME and/or LCH to differ slightly from the ISDA LIBOR Fallbacks Protocol. Each central counterparty (CCP) has announced a proposal and discussion document on how they each look to transition away from LIBOR. Although both the CME and LCH rulebooks currently reference the 2006 ISDA Definitions, and any new or legacy transaction now incorporates the ISDA IBOR Fallbacks Supplement, the CCPs are investigating whether they will have LIBOR transactions transition in the exact manner as laid out in the ISDA IBOR Fallbacks Protocol. Chatham has provided direct feedback to both the LCH and CME on behalf of our clients with our concerns on their proposals. Both CCPs have been very receptive to hearing feedback and are willing to listen to your direct feedback. We would encourage you to connect directly with both CCPs as they have been very receptive to hearing feedback on the proposed changes.