To the extent that the market participants do rely on synthetic LIBOR, their efforts to transition should continue. It is also important that market participants understand if and how the FCA exercising its use restriction power will affect them and take any necessary steps to prepare themselves.
4. Statutory replacement rates
As a result of the statutory replacement of CHF LIBOR and EONIA enacted by the EU legislator, certain contracts and financial instruments linked to CHF LIBOR and EONIA were automatically replaced with references to SARON plus the adjustment spread and €STR plus 8.5 bp on 1 January, 2022 and 3 January, 2022 respectively.
In December 2021, we saw continued activity from regulators and working groups to support an orderly transition away from LIBOR by providing market participants with further tools, notably in relation to statutory replacement rates for additional LIBORs.
On 24 December 2021, the European Commission (EC) announced that it will be issuing implementing acts to designate replacement rates for certain GBP LIBOR and JPY LIBOR in Q1 2022. This comes in response to the FCA announcement to allow all contracts (except cleared derivatives) to use synthetic versions of GBP and JPY LIBOR until the end of 2022. It also takes into consideration the demands expressed by the Working Grouping on Euro Risk Free Rates (EUR RFR WG) asking to designate replacement rates for GBP LIBOR and JPY LIBOR to ensure legal certainty beyond 2022 and consistency with the EU Benchmark Regulation (BMR).
However, it can be expected that like for the previous statutory replacement rate enacted in 2021, the statutory designation will not provide a universal solution. Indeed, article 23a of the BMR limits the effect of designation of a statutory replacement to i) any contract, or any financial instrument that references a benchmark and is subject to the law of one of the Member States; and ii) any contract, the parties to which are all established in the Union, that references a benchmark and that is subject to the law of a third country and where that law does not provide for the orderly wind-down of a benchmark. It is therefore important that market participants continue to focus on the active transition of legacy contracts wherever possible without relying on the statutory replacement solution.
The Alternative Reference Rates Committee (ARRC) also published at the beginning of December 2021 statutory fallback recommendations for 1-week and 2-month USD LIBOR contracts affected by the State LIBOR Legislation. Those LIBOR tenors are not published after 31 December 2021.
The ARRC highlighted in its recommendations that references to 1-week and 2-month USD LIBOR are uncommon, and therefore the recommendations apply only to the narrow set of LIBOR-based contracts that are affected by the State LIBOR Legislation, generally contracts with no fallbacks or fallbacks that reference LIBOR. Further, it is worth highlighting that the State LIBOR Legislation will only apply to in-scope New York-law-governed contracts. For contracts with fallbacks that give a party (such as the lender or noteholder) discretion to choose a replacement rate, the State LIBOR Legislation also provides a safe-harbor if that party chooses the SOFR-based rate and conforming changes recommended by the ARRC.
The State LIBOR Legislation may therefore have allowed a narrow set of LIBOR-based contracts to successfully move off LIBOR. However, market participants should continue to focus converting remaining USD LIBOR contracts by mid-2023.
5. Possible transition and cessation of other IBORs
As the industry approached the end-2021 deadline, we witnessed increased focus from the industry on the transition of other IBORs.
Notably, ISDA published a new set of fallbacks for derivatives referenced to certain IBORs not covered by ISDA’s initial fallback rollout earlier in 2021. The new fallbacks cover IBORs in India (MIFOR), Malaysia (KLIBOR), New Zealand (BKBM), Norway (NIBOR), the Philippines (PHIREF) and Sweden (STIBOR), ensuring a robust replacement based on RFRs would automatically take effect if any of those benchmarks permanently ceases to exist.
ISDA also published a supplement to the 2006 ISDA Definitions plus a new version of the 2021 ISDA Interest Rate Derivatives Definitions to enable parties to include the fallbacks into new derivatives transactions from 16 December 2021. The December 2021 Benchmark Module of the ISDA 2021 Fallbacks Protocol has also been published to allow firms to incorporate the fallbacks into all legacy derivatives contracts with counterparties that also adhere to the protocol. That module is also effective from 16 December 2021, and other modules covering additional IBORs may be published in future.
Going forward, market participants should monitor their exposure to potentially impacted IBORs and consider adhering to the ISDA protocol module where applicable, which would ensure robust fallbacks were in place if any of the impacted IBOR ceased to exist.
The Canadian Alternative Reference Rate Working Group (CARR) also published a White Paper on the recommended future of CDOR. The White Paper recommends that Refinitiv, the administrator of CDOR, cease publication of all of CDOR’s remaining tenors after 30 June 2024. The CARR’s recommendation is therefore to align with regulators globally moving financial markets away from credit-sensitive benchmarks to RFRs. Market participants may potentially wish to anticipate any new use of CDOR, however, it is worth noting that the White Paper is a recommendation only; the decision to cease CDOR ultimately lies solely with Refinitiv.
Finally, the discussion around EURIBOR is open and regulators will wait until LIBOR cessation is completed. Nevertheless, as part of their BMR compliance, the institutions need to make sure to have robust fallbacks (€STR based) in place legally and operationally in case of disruption or cessation of EURIBOR in the future.