The UK’s Financial Conduct Authority (FCA) has made it clear that the publication of LIBOR, the London Interbank Offered Rate, will cease. With the approaching end to LIBOR as an interest rate index, financial institutions and individuals or entities with loans that could be impacted need to understand what this change means in order to limit disruption and mitigate risk.
On March 5, 2021, the ICE Benchmark Administration, the benchmark administrator for LIBOR (IBA), and the UK Financial Conduct Authority, the regulatory supervisor of the IBA (FCA), (External)announced the dates after which all 35 LIBOR settings will either cease to be provided or will no longer be representative.
All sterling, euro, Swiss franc, and Japanese yen IBOR rates ceased to be available as of January 1, 2022.
One-week and two-month USD LIBOR tenors ceased to be available as of January 1, 2022.
All other USD LIBOR tenors will no longer be available after the end of June 2023.
Following this announcement, the fallback spread adjustments were published and set by Bloomberg, effective March 5, 2021. These actions did not trigger implementation of a new reference rate for existing loans or swaps.
LIBOR has been used globally as a benchmark to gauge funding costs and investment returns for financial contracts for more than 3 decades. It is used to help set the interest rates on many loans, swaps, bonds, credit cards, adjustable rate mortgages, and other products offered by financial institutions.
Changing industry norms and LIBOR manipulation scandals are driving a shift away from LIBOR, causing interbank lending markets to become much thinner and the number of actual transactions upon which the rate is based to decrease significantly. That has caused regulators globally to actively advocate that markets move away from LIBOR to a more reliable index.
PNC has a large team dedicated to this transition that is active in many industry working groups and closely engaged with market activities. For existing LIBOR-based loans and associated underlying derivative contracts maturing beyond June 2023 that do not contain adequate provisions addressing LIBOR cessation, PNC has contacted clients to add or amend those provisions or to move to another replacement rate. For clients that have not yet amended their LIBOR loans or derivatives contracts to include adequate provisions for index replacement, upon LIBOR cessation, PNC will act in accordance with the existing contract terms and, where applicable, in consideration of the LIBOR Act, a law passed by Congress to ease the transition from LIBOR.
Due to regulatory guidance, PNC can no longer originate new LIBOR-based loans or accommodate certain modifications to LIBOR-based loans. Clients with LIBOR-based committed facilities which closed on or prior to December 31, 2021 can continue to borrow and maintain loans at contractual LIBOR-based rates until June 30, 2023 (or, if earlier, such time as they request certain amendments to the loan).
PNC and other market participants have implemented various rate alternatives, including the Secured Overnight Financing Rate (SOFR) and Bloomberg’s Short-Term Bank Yield Index (BSBY).
The Alternative Reference Rates Committee (ARRC), an industry group convened by the Federal Reserve Board and the New York Fed, recommends using the Secured Overnight Financing Rate (SOFR). SOFR is considered a more robust reference rate than LIBOR as it is wholly based on actual transactions and represents an active daily market (over $800B in transactions).
Bloomberg has developed a credit sensitive Short-Term Bank Yield Index (BSBY) based on transaction related data, including both actual executed transactions and firm executable quotes (over $200B in transactions).
Although LIBOR and SOFR reflect short-term borrowing costs and are available in multiple tenors, they are calculated very differently:
BSBY was constructed to be different from LIBOR and designed to meet a market need:
Due to the anticipated discontinuation of LIBOR, loans originated or modified in the past couple of years have included fallback language outlining a detailed mechanism to amend the loan documents to incorporate a new reference rate to replace LIBOR, as well as a spread and other adjustments to account for differences between LIBOR and the new reference rate.
As of January 1, 2022, if a client seeks an amendment to an existing LIBOR-based loan that extends the tenor, increases the size or amends the pricing, that amendment will be required to implement a rate other than LIBOR.
For existing LIBOR-based loans maturing beyond June 2023 that do not contain adequate provisions addressing LIBOR cessation, PNC will contact clients to add or amend those provisions or to move to another replacement rate.
If an amendment is not completed, PNC will adhere to the existing contract and federal law (LIBOR Act).
PNC is able to offer swap fallback provisions that will maintain maximum alignment between a client’s swap and existing loan.
As of January 1, 2022, PNC will only enter into a LIBOR-based swap with a client if that swap is hedging or reducing the client’s LIBOR exposure on contracts entered into before January 1, 2022.
Related to swap fallbacks: Swap documentation historically has not provided for a fallback rate if LIBOR were to be permanently discontinued. In January 2021, the International Swaps and Derivatives Association (ISDA) finalized an update to its derivatives definitions to include LIBOR cessation fallback provisions. These updates name the LIBOR replacement rate as SOFR (compounded in arrears) plus a spread adjustment based on the 5-year median spot difference between USD LIBOR and SOFR. The updated definitions were published and are effective for any new or amended LIBOR swap contracts executed on or after January 25, 2021.
However, clients have options to choose other fallbacks to preserve maximum symmetry between a loan and associated swap. PNC loans entered into or amended after November 2020 generally include hardwired replacement provisions that are consistent with those recommended by ARRC (the committee convened by the Federal Reserve Board to focus on LIBOR transition).
Related to legacy swaps without adequate fallbacks: For existing swap contracts maturing beyond June 2023, PNC will contact clients to amend and incorporate adequate fallback language and replacement provisions.
PNC representatives have reached out to clients to address updates to legacy LIBOR loans and swaps that still require updates prior to cessation on June 30, 2023. As PNC acts on the index replacement language incorporated into loan documentation, clients can expect a communication explaining the change that will be made to their loan.
As the transition away from LIBOR has progressed, the SOFR derivative market has primarily been focused on Daily Simple SOFR, an overnight rate. When using overnight SOFR rates on both loan and swap products, clients can typically expect to receive their invoice on the due date. Delivering invoices on the due date allows PNC to provide exact (i.e. not estimated) invoices to help clients match their loan and swap payments. Clients that prefer a longer lead time should contact their Relationship Manager or Loan Administrator and we can provide an estimated invoice further in advance of the payment due date.
ARRC is group of private-market participants convened by the Federal Reserve Board and the New York Fed.
In 2017, the ARRC selected SOFR as the rate that represents best practice for use in certain new USD derivatives and other financial contracts.
Overview of Bloomberg’s development of BSBY – a dynamic credit sensitive rate with a forward term structure.
ISDA is comprised of a broad range of derivatives market participants.
Visit ISDA Transition from LIBOR »
Working within the Federal Reserve System, the New York Fed implements monetary policy, supervises and regulates financial institutions and helps maintain the nation's payment system.
1. https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2018/ARRC-Second-report
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