The UK’s Financial Conduct Authority (FCA) has made it clear that the publication of LIBOR, the London Interbank Offered Rate, will cease. LIBOR, a benchmark interest rate at which major global banks lend to one another in the interbank market, is underpinning over $200 trillion USD of financial contracts. 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, the ICE Benchmark Administration, the benchmark administrator for LIBOR (IBA), and the UK Financial Conduct Authority, the regulatory supervisor of the IBA (FCA), the dates after which all 35 LIBOR settings will either cease to be provided or will no longer be representative. This confirmation was expected following a similar November 30 by the Federal Reserve Board around the proposed cessation dates and provides certainty regarding when LIBOR rates will no longer be available.
Following this announcement, the fallback spread adjustments published by Bloomberg were set, effective March 5, 2021. The announcement does not trigger implementation of a new reference rate for existing loans or swaps.
The Federal Reserve Board, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency previously issued guidance encouraging banks to stop entering new USD LIBOR contracts as soon as practicable, but no later than December 31, 2021. Further, regulators have directed banks that any new lending or derivatives contracts entered into during 2021 should utilize an alternative index rate or include fallback language that clearly defines an alternative index rate following the discontinuing of LIBOR.
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. No action is required of clients at this time. PNC will provide further updates and new documents or amendments to existing documents to facilitate the transition as replacement reference rates are identified and implemented in the financial industry generally.
Neither the industry nor PNC has found a perfect replacement for LIBOR. While certain rates receive many of the headlines, additional alternatives are still being considered.
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 $750B in transactions).
Although LIBOR and SOFR reflect short-term borrowing costs, they are calculated very differently:
Loan documentation generally provides that if LIBOR is no longer available, the interest rate will be based on the Prime Rate.
Due to the anticipated discontinuation of LIBOR, recently originated or modified loans include 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 December 2020, PNC’s fallback language adopts a ‘hardwired approach’ that specifically identifies SOFR as the new reference rate.
Swap documentation historically has not provided for a fallback rate if LIBOR were to be permanently discontinued. The International Swaps and Derivatives Association (ISDA) recently finalized an update to its derivatives definitions to include LIBOR cessation fallback provisions. The ISDA LIBOR replacement rate will be 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 all swap contracts executed on or after January 25, 2021.
ISDA has also published a 2020 IBOR Fallbacks Protocol as a means to amend legacy swap contracts to include the new derivatives fallback provisions. PNC is adhering to the 2020 IBOR Fallbacks Protocol.
For existing swap contracts maturing beyond June 2023, PNC will contact clients to amend and incorporate adequate fallback language and replacement provisions.
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The information contained in this site is of a general nature and does not constitute the provision by PNC of investment, legal, tax, or accounting advice. Opinions expressed herein are subject to change without notice. The information was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy.
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