Global IBOR Reforms

Update for all investors

An international initiative has been launched to reform interbank offered rates (“IBORs”) and to develop more robust alternatives. This move was prompted by the widely publicised cases of attempted manipulation by traders from prominent investment banks of various IBORs. IBORs are important because they are frequently used as a benchmark or target return for many funds, as well as underpinning various financial instruments and products. IBORs may also be present in other non-financial contractual arrangements.

Regulators around the world have been engaging with market participants, including banks and asset managers, to consider how best to transition to new alternative risk free rates (“RFRs”). Legal & General has participated in various market work streams led by the Bank of England to help all aspects of the UK market transition.

The transition away from IBORs represents a significant challenge, particularly for banks, asset managers and financial services firms across the industry. Estimates of the amount of IBOR-related activity in the banking and financial sector vary, but all point to global exposures in the hundreds of trillions. A significant amount of work across all market participants is therefore required to ensure a smooth transition.

When will this happen?

It is expected that IBORs start to be discontinued during 2021. The dates will depend on the respective decisions of each relevant IBOR supervisory authority / administrator.

With regards to the London Interbank Offer Rate (“LIBOR”), from December 2021 banks will no longer be compelled to submit quotes to determine it, effectively discontinuing the rate. As a consequence, substantial shifts in global trading and transition activity to alternative RFRs have been taking place and are expected to continue throughout 2021.

This is a market-led transition that depends heavily on the developments of market participants, which are being enabled by numerous industry groups. LGIM are monitoring these developments closely and taking action where appropriate in the interest of our clients. The UK has been the global leader in transition progress. The widely accepted LIBOR fall-back has been the alternative RFR, SONIA, which is already well developed in the derivatives market, with early transition activity within the cash and loans markets.

How will it affect your investments with us?

We have made significant progress in identifying and addressing our clients’ investment exposure to IBORs and have an established governance structure around our transition activity. We are also working in partnership with our parent company Legal & General Group PLC, who have established thorough and strong governance with a central co-ordination oversight, supported by divisional delivery.

This allows us to share project management and legal expertise to ensure an effective and controlled transition pipeline ahead of the December 2021 deadline.

What are the risks for LIBOR-referenced investments?

The FCA has reiterated that market participants should not depend on LIBOR beyond 2021. The transition involves a two-way path: (i) establishing multiple new products, and (ii) changing existing IBOR-referenced products. It also affects products across different jurisdictions which are transitioning to different alternative rates at different times.

  1. Transfer of economic value when moving IBORs to RFRs
  2. Operational process changes
  3. Amending legal agreements
  4. Liquidity risks of terminating IBOR instruments and replacing these with alternative RFR instruments

All these risks are being monitored closely at LGIM.

January 2021 Update

Despite the impacts from COVID-19 the market initiative to transfer away from certain currency IBORs has continued to progress with the current deadline for the termination of GBP LIBOR on 31st December 2021 unchanged. The UK Financial Conduct Authority (FCA) along with the Bank of England have held several roundtables and published further guidance to ensure the market stays focused on this target date.

Transition from LIBOR | FCA

Financial market players and organisations have been gradually taking steps to mitigate the impact of the transition from IBORs to RFRs. One of these steps includes the publication by the International Swaps and Derivatives Association (“ISDA”) of the ISDA 2020 IBOR Fallbacks Protocol (“ISDA Protocol”) which market participants have been encouraged to adopt as part of their existing trading documentation.

What is the ISDA Protocol?

ISDA are an organisation who facilitate and set market standards in the trading of financial derivatives, usually traded under ISDA standardised Master Agreements. These instruments are often traded using IBOR rates. Notwithstanding ISDA’s primary role of being a global sounding board for derivatives transactions, given its global reach and influence in financial markets, ISDA has, in certain occasions created industry-wide protocols that have a wider scope than derivatives and ISDA-owned master agreements. With that in mind, in October 2020, ISDA published the ISDA Protocol with the aim to amend the terms of a wide range of market standard trading agreements such as ISDA Master Agreements, Global Master Repurchase Agreements, Global Master Securities Lending Agreements and International Foreign Exchange Master Agreements, to name a few, to ensure that on the permanent cessation of an IBOR or when an IBOR is deemed no longer representative a fallback rate is in place to provide for the continuation of the relevant IBOR linked trade and/or commercial provision.

The fallback rates have been determined via a market consultation and are now published as the selected currency RFR + a spread to ensure minimal value transfer on the removal of each relevant IBOR.

Further information on the Protocol and its expanded scope can be found here: ISDA 2020 IBOR Fallbacks Protocol – International Swaps and Derivatives Association

LGIM, acting as agent, has adhered to the Protocol and is also in the process of adhering all Clients that have provided us with consent to do so.

The FCA has also announced new regulatory intervention powers to support what are deemed ‘Tough Legacy’ where there is no practical way to transition an existing IBOR exposure. The regulator recognises a potential need to support such positions past the discontinuation of IBOR in the interest of Consumers.

Progress is being made too across the pond with the US Transition body ARRC, who are also taking similar steps to promote the Secured Overnight Financing Rate (SOFR) as the new RFR to USD LIBOR. This is positive for the Global transition effort and will ensure the market is fully prepared to meet its obligations.

ARRC_Press_Release_Guide_Endgame_USD_LIBOR.pdf (newyorkfed.org)

At LGIM we continue to monitor the transition steps required and the associated risks, working closely with the FCA and the PRA on behalf of L&G and our clients. We are pleased to confirm that COVID-19 has not impacted our efforts and our transition programme remains on target.

Do you need to do anything?

You do not need to take any action with respect to your investments with LGIM. We will be in touch regarding your investments as appropriate, so please do look out for communications from us on this matter. However, if you are potentially impacted by the transition in other ways, please seek appropriate legal advice and guidance. You can also contact your usual LGIM representative if you would like to discuss this regulatory change and potential impact on your investments in more detail.

Further information can be found here:
https://www.bankofengland.co.uk/markets/transition-to-sterling-risk-free-rates-from-libor (link is external)

What are IBORs?

IBORs (Inter Bank Offer Rates) are financial benchmarks showing the average rates at which major banks can borrow in the interbank market. They are forward-looking, unsecured rates and range from overnight to 12 months.

IBORs also act as reference rates to hundreds of trillions of dollars in notional derivative exposure, for example interest rate swaps, and trillions of dollars in bonds, loans, mortgages, securitisations and deposits across institutional, corporate and retail market participants.

IBORs exist in different currencies. For example, GBP LIBOR is the rate at which UK banks can borrow from one another in sterling, and USD LIBOR is the rate at which banks can borrow from each other in US dollars.

What are the alternatives to IBORs?

Alternative Risk Free Rates (“RFRs”) are being established across the different IBOR jurisdictions. In the UK, the Bank of England has recommended that reformed SONIA (Sterling Over Night Index Average) be used as the sterling near risk-free reference rate and has promoted its adoption as an alternative to GBP LIBOR.

Alternative RFRs are intended to be more representative and robust. In addition to the manipulation scandals, the number of transactions underpinning the rates set by IBORs has been declining; as a result of post-financial crisis reforms, banks often now favour secured lending through deposits, repos and bonds. This means that IBORs are no longer a true reflection of the markets they are designed to represent.

What role is LGIM playing in the transition?

LGIM, along with our parent company Legal & General, have been engaged in the UK market transition at various levels with the Bank of England and other leading industry organisations, including the Investment Association, since 2017. Through these forums and our engagement with our counterparties and clients, we have been able to plan our transition away from IBORs ahead of the December 2021 deadline.

The global impact

JurisdictionWorking GroupAlternative Ref
Rate Name
AdministratorCollateralisationsDescription
United States of America

Alternative Reference Rates Committee (link is external)

Secured Overnight Financing Rate (SOFR) (link is external)

Federal Reserve Bank of New York

Secured

Secured rate that covers multiple overnight repo market segments

United Kingdom

Working Group on Sterling Risk-Free Reference Rates (link is external)

Sterling Overnight Index Average (SONIA) (link is external)

Bank of England

Unsecured

Unsecured rate that covers overnight wholesale deposit transactions

Switzerland

The National Working Group on CHF Reference Rates (link is external)

Swiss Average Rate Overnight (SARON) (link is external)

SIX Exchange

Secured

Secured rate that reflects interest paid on interbank overnight repo rate

Japan

Study Group on Risk-Free Reference Rates (link is external)

Tokyo Overnight Average Rate (TONAR) (link is external)

Bank of Japan

Unsecured

Unsecured rate that captures overnight call rate market

Euro area

Working Group on Risk-Free Reference Rates for the Euro Area (link is external)

Euro short-term rate (€STR) (link is external)

European Central Bank

Unsecured

Unsecured rate that captures overnight wholesale deposit transactions

Source: FCA