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The replacement of LIBOR
The FCA announced in 2017 its intention to stop compelling banks to submit the rates required to calculate LIBOR after the end of 2021. The FCA and other regulators have encouraged participants in the financial markets to take steps to stop using LIBOR by this date. The future of LIBOR is therefore not guaranteed beyond the end of 2021.
In light of this, it is important that our customers understand what the transition entails and the actions they should consider taking to prepare their businesses. Santander UK will also be contacting customers to outline our intended approach.
What is LIBOR?
The London Interbank Offered Rate (LIBOR) is used in the calculation of interest and other payments under many loans, derivatives, bonds and other financial transactions, both in the UK and abroad.
LIBOR is a set of benchmark interest rates that provide an indication of the average rates at which panel banks could borrow wholesale, unsecured funds for set periods in particular currencies. It is calculated and published daily by the Intercontinental Exchange (ICE) Benchmark Administrator (IBA) based on submissions from a panel of banks. It is published across a range of currencies (GBP, USD, EUR, JPY and CHF) and maturities (overnight, one week, one month, two months, three months, six months and one year).
It is estimated that LIBOR underpins around $300tn ($30tn in sterling markets) of financial contracts including, derivatives, bonds and loans.
Why does LIBOR need to be replaced?
The underlying market that LIBOR measures is no longer used in any significant volume. Therefore, the submissions made by banks to sustain the LIBOR rate are often based (at least in part) on expert judgement rather than actual transactions.
The UK’s Financial Conduct Authority (FCA) has concluded that the way in which LIBOR is calculated in practice means that it no longer complies with internationally accepted principles for robust interest rate benchmarks. As such, in 2017, the FCA announced its intention to stop compelling banks to submit the rates required to calculate LIBOR after the end of 2021.
What will replace LIBOR?
Since the FCA’s announcement in 2017, the UK authorities – the FCA, the Prudential Regulation Authority (PRA) and the Bank of England – have encouraged a transition from LIBOR to alternative interest rates before the end of 2021, calling this transition “critical”.
Dave Ramsden, the Deputy Governor for Markets and Banking at the Bank of England, said in June 2019 that “The best way to make the most of the timetable set for LIBOR to end is for markets to focus on transitioning away from it, to new risk free rates”, and he encouraged firms “to educate their customers”.
In the UK, the Working Group on Sterling Risk-Free Reference Rates (the RFR Working Group) has been established to develop alternative rates to replace GBP LIBOR and oversee transition. Santander UK was one of the founding members.
In April 2017, the RFR Working Group recommended SONIA – the Sterling Overnight Index Average – as its preferred alternative reference interest rate for sterling transactions (although it is possible to transition to others rates as well). Since then, the RFR Working Group has been focused on how to implement transition across sterling markets.
Is this transition only happening in the UK?
No. Similar initiatives are underway globally, including in the US, Euro Area, Switzerland and Japan where alternative interest rate benchmarks have also been nominated:
|Currency||Reference rate||Proposed alternative rate||Features||Forum|
|USD||USD LIBOR*||SOFR (Secured Overnight Financing Rate)||Secured,|
|The Alternative Reference Rates Committee|
|€STR (Euro Short-Term Rate)**||Unsecured,|
|Working group on euro risk-free rates|
|CHF||CHF LIBOR||SARON (Swiss Average Rate Overnight)||Secured,|
|The National Working Group on Swiss Franc Reference Rates|
|JPY||JPY LIBOR |
|TONAR (Tokyo Overnight Average Rate)||Unsecured,|
|Study Group on Risk-Free Reference Rates|
*The US Alternative Reference Rates Committee also anticipates some interest rate references migrating from the Effective Fed Funds Rates to SOFR.
** The ECB plans to start publishing €STR on 2 October 2019.
When will the transition take place?
Authorities and industry groups are working through the implications and the issues generated by the transition from LIBOR to the alternative interest rate benchmarks. This includes work on the market conventions for interest provisions based on alternative interest rate benchmarks (and the transition of LIBOR interest terms to them) and the potential development of forward-looking term rates for the alternative interest rate benchmarks.
However, the pace of the transition is not currently uniform or coordinated across each alternative interest rate benchmark and products. It is also not clear at this stage when new market conventions will emerge or if they will be consistent across products or currencies. In particular, it is not clear if or when forward-looking term rates for various alternative interest rate benchmarks will be developed.
The picture is likely to become clearer later in 2019 or in the first half of 2020.
What are the differences between LIBOR and alternative interest rate benchmarks?
There are some important differences that may have an impact on the terms of your transactions and products with Santander UK.
For example, LIBOR is a forward-looking term rate, which means that the LIBOR rate for an interest period or calculation period is set at the start of that period, with payment due at the end. As such, this provides certainty of funding costs to assist cashflow management. Also, LIBOR embeds a credit premium (it implies bank credit risk) and a liquidity premium (it includes a premium for longer dated funds).
In contrast, the nominated alternative interest rate benchmarks are mostly backward-looking overnight rates. They are designed to be near risk-free and with no premium for term.
These differences have implications for how interest and other payments based on alternative interest rate benchmarks may be calculated relative to LIBOR based transactions and products.
The transition of existing LIBOR based contracts to contracts referencing alternative interest rate benchmarks may involve the payment of a spread adjustment and may impact the operation of certain financial covenants. There may also be cash-flow and hedge accounting impacts if a mismatch arises on transition between a loan and a related derivative.
More information is available here:
What does LIBOR transition mean for customers?
The transition to alternative interest rate benchmarks will impact a range of transactions and products. You should expect to be affected if you have a floating rate loan or credit facility, deposit or derivative with Santander UK that has or may have payments linked to LIBOR or other affected legacy benchmarks that mature after 2021.
There are several differences between LIBOR and the proposed alternative interest rates and, as a result, the transition may have pricing, cashflow, accounting and operational implications for you and your business.
Authorities and industry groups are still working through the implications and issues generated by the transition, including how best to transition to new and existing products and transactions to the alternative interest rate benchmarks across the range of products by the end of 2021, if not before. Santander UK continues to monitor these developments and evolve our transition plans as required.
Santander UK is working to keep affected customers and their businesses informed though this transition. We will contact you in due course with details on our proposed approach to the use of the alternative interest rate benchmarks, including when Santander UK will cease to offer legacy benchmark based products and how we would propose to deal with existing legacy benchmark based transactions or products (including the changes we may seek to make to their terms).
What should you do now?
There are a number of steps that you may wish to take now. For example:
- review information available on LIBOR and other legacy benchmark transition (including through the selection of links we have provided below);
- undertake a review of any transactions you have that are based on LIBOR and other legacy benchmarks;
- consider the potential impacts that the discontinuation of LIBOR and other legacy benchmarks may have on your business;
- consider the potential impacts that the transition to alternative interest rate benchmarks may have on your business; and
- consider seeking advice from your financial and/or legal advisers.
If you would like to discuss this matter further with Santander UK, please contact your Santander UK relationship director.
Where can you find more information?
More information on SONIA and LIBOR transition in the UK is available from the RFR Working Group:
- Bank of England - Transition to sterling risk-free rates from Libor
- Bank of England - SONIA interest rate benchmark
The websites of trade bodies contain additional information, including: