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INTEREST RATE BENCHMARK REFORM – LONDON INTERBANK OFFERED RATE (LIBOR)

Worldwide transition away from LIBOR

LIBOR, formerly one of the world’s most common benchmark interest rates, has been used for decades in financial products like business loans and adjustable-rate mortgages. However, a worldwide transition has been completed to replace it with rate alternatives. This transition may impact some existing contracts that use LIBOR as a benchmark rate, and for new contracts, regulators have made it clear that LIBOR shouldn’t be used.

We planned extensively and were well-positioned to make this a smooth transition for customers who might be impacted by the change. We offer a variety of newer interest rate alternatives, including the Secured Overnight Financing Rate (SOFR), and the Bloomberg Short-Term Bank Yield Index (BSBY).

Recommended alternative reference rates for LIBOR

Country

United States

United Kingdom

Europe

Switzerland

Japan

LIBOR Rate

USD LIBOR

GBP LIBOR

EURIBOR AND EUR LIBOR

CHF LIBOR

JPY LIBOR,

JPY TIBOR, EUROYEN TIBOR

Alternative Replacement Rate

Secured Overnight Financing Rate (SOFR)

Sterling Overnight Interbank Average Rate (SONIA)

European Short-Term Euro Rate (€STR)

Swiss Average Rate Overnight (SARON)

Tokyo Overnight Average Rate (TONAR)

Description

Multiple overnight repo market segments

Overnight wholesale deposit transactions

Overnight wholesale deposit transactions

Interest paid on interbank overnight repo average

Overnight call rate market

Secured

Yes

No

No

Yes

No

Administrator

Federal Reserve Bank of New York

Bank of England

European Central Bank

SIX Swiss Exchange

Bank of Japan

Country

LIBOR Rate

United States

USD LIBOR

United Kingdom

GBP LIBOR

Europe

EURIBOR AND EUR LIBOR

Switzerland

CHF LIBOR

Japan

JPY LIBOR,

JPY TIBOR, EUROYEN TIBOR

Country

Alternative Replacement Rate

United States

Secured Overnight Financing Rate (SOFR)

United Kingdom

Sterling Overnight Interbank Average Rate (SONIA)

Europe

European Short-Term Euro Rate (€STR)

Switzerland

Swiss Average Rate Overnight (SARON)

Japan

Tokyo Overnight Average Rate (TONAR)

Country

Description

United States

Multiple overnight repo market segments

United Kingdom

Overnight wholesale deposit transactions

Europe

Overnight wholesale deposit transactions

Switzerland

Interest paid on interbank overnight repo average

Japan

Overnight call rate market

Country

Secured

United States

Yes

United Kingdom

No

Europe

No

Switzerland

Yes

Japan

No

Country

Administrator

United States

Federal Reserve Bank of New York

United Kingdom

Bank of England

Europe

European Central Bank

Switzerland

SIX Swiss Exchange

Japan

Bank of Japan

The difference between SOFR and LIBOR

In 2017, the Alternative Reference Rates Committee (ARRC), a committee convened by the Federal Reserve Board and the Federal Reserve Bank of New York in 2014, identified SOFR as the recommended alternative to USD LIBOR. SOFR is a secured-overnight rate, while LIBOR is a term, unsecured rate. SOFR is calculated based on a larger amount of underlying transactions, averaging more than $900 billion in daily transactions in 2021. In contrast, LIBOR reflects the funding costs of panel banks.

Metric

LIBOR

SOFR

Term SOFR

Tenor Coverage

Overnight, one, three, six months

Overnight

One, three, six and twelve months

Underlying Data Source

Submission by panel banks based on estimations of underlying market and expert judgment

Transaction based on overnight repo transactions

Transactions based on one-month and three-month SOFR Futures contracts

View

Forward-looking

Overnight backward looking

Forward-looking

Determination of Costs

Weighted average of submitted rates after eliminating some higher and lower rates

Volume-weighted median of actual transactions (for combined repo datasets)

Volume-weighted one-month and three-month SOFR futures contracts

Credit Risk

Embedded credit risk component due to bank risk

Near to risk-free, as repo transactions are collateralized by U.S. Treasury securities

Near to risk-free, as repo transactions are collateralized by U.S. Treasury securities

Interest Calculation

Payments known at the beginning of the accrual period

Daily rate, with interest accrued and paid in arrears. Interest due known at the end of the accrual period

Payments known at the beginning of the accrual period

Metric

Tenor Coverage

LIBOR

Overnight, one, three, six months

SOFR

Overnight

Term SOFR

One, three, six and twelve months

Metric

Underlying Data Source

LIBOR

Submission by panel banks based on estimations of underlying market and expert judgment

SOFR

Transaction based on overnight repo transactions

Term SOFR

Transactions based on one-month and three-month SOFR Futures contracts

Metric

View

LIBOR

Forward-looking

SOFR

Overnight backward looking

Term SOFR

Forward-looking

Metric

Determination of Costs

LIBOR

Weighted average of submitted rates after eliminating some higher and lower rates

SOFR

Volume-weighted median of actual transactions (for combined repo datasets)

Term SOFR

Volume-weighted one-month and three-month SOFR futures contracts

Metric

Credit Risk

LIBOR

Embedded credit risk component due to bank risk

SOFR

Near to risk-free, as repo transactions are collateralized by U.S. Treasury securities

Term SOFR

Near to risk-free, as repo transactions are collateralized by U.S. Treasury securities

Metric

Interest Calculation

LIBOR

Payments known at the beginning of the accrual period

SOFR

Daily rate, with interest accrued and paid in arrears. Interest due known at the end of the accrual period

Term SOFR

Payments known at the beginning of the accrual period

The ARRC has formally recommended the forward-looking Term SOFR rates developed by CME Group (“CME Term SOFR”), a leading derivatives market operator.

Our top priority is keeping you informed on industry developments and our transition efforts as we work collaboratively with customers to update LIBOR contracts. If you’d like more information, make an appointment to meet with us virtually, on the phone or in person. We also encourage you to seek independent professional advice on any questions or concerns you may have.

Key industry developments

ARRC Advisory Group formed to identify alternative reference rate for USD LIBOR

The ARRC formed an advisory group with participation across a wide set of market participants (banks, asset managers, corporate treasurers, and industry trade associations) to help ensure a successful transition from the U.S. dollar (USD) LIBOR to a more robust reference rate. U.S. Bank has representation on several of the ARRC’s working groups and continues to be actively engaged in peer banks’ discussions on the LIBOR transition.

ARRC announces preferred alternative reference rate

The ARRC identified SOFR as the recommended alternative to USD LIBOR. SOFR is published each business day by the Federal Reserve Bank of New York.

Announcement regarding the end of LIBOR publications

The ICE Benchmark Administration (IBA), the benchmark administrator for LIBOR, and Financial Conduct Authority (FCA) announced that after Dec. 31, 2021, the UK regulator would not compel panel banks to submit LIBOR. This announcement was an important step towards the end of LIBOR and confirmed that all LIBOR settings would either cease to be provided by any administrator or no longer be representative.

ISDA launches IBOR Fallbacks Protocol

The International Swaps and Derivatives Association (ISDA) published its Supplement to the 2006 ISDA Definitions to update fallback provisions for IBORs and, at the same time, published the new ISDA IBOR Fallbacks Protocol in anticipation of LIBOR’s discontinuation at the end of 2021, its original proposed cessation date.

The IBOR Fallback Protocol and the Supplement took effect on Jan. 25, 2021, and provide robust fallback provisions to be applied upon permanent cessation of a relevant IBOR like LIBOR or a pre-cessation announcement with respect to LIBOR. And later, in 2021, ISDA published the 2021 ISDA Interest Rate Derivatives Definitions (the “2021 ISDA Definitions”), which include all of the updates provided in the ISDA 2006 Definitions Supplement and more. The 2021 ISDA Definitions have been widely adopted throughout the derivatives industry.

The IBOR Fallbacks Protocol also provides an efficient amendment mechanism for mutually adhering counterparties to incorporate the fallback provisions into legacy contracts. The IBOR Fallbacks Protocol and Supplement do not modify the terms of underlying floating rate exposures or ensure such exposures transition in the same manner as any interest rate derivatives entered to hedge those exposures.

Market participants should work closely with their legal counsel and financial advisors to ensure that they understand the role and impacts of the IBOR Fallbacks Protocol, the Supplement and the 2021 ISDA Definitions within their overall LIBOR transition strategy.

IBA proposes dates on the LIBOR cessation timeline

The IBA announced the proposed dates when all 35 LIBOR settings would either cease to be provided or will no longer be representative:

After Dec. 31, 2021:
One-week and two-month USD LIBOR tenors, as well as all sterling, euro, Swiss franc, and Japanese yen LIBOR rates, ceased to be available or became unrepresentative. Certain tenors of sterling and Japanese yen LIBOR rates are still being published on a synthetic, unrepresentative basis for certain contracts.

After June 30, 2023:
All other USD LIBOR tenors will no longer be available.

The announcement by the IBA was subject to consultation with market participants that was scheduled to be completed during 1Q 2021.

U.S. regulators jointly announce guidance on new LIBOR loans

On Nov. 30, 2020, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation jointly encouraged supervised institutions to cease entering new U.S. dollar (USD) LIBOR contracts no later than Dec. 31, 2021, except for in a few limited circumstances.

IBA and FCA announce cessation timeline for LIBOR settings

Having completed their consultation with market participants, the IBA and FCA confirmed the future cessation dates or loss of representativeness of the 35 LIBOR benchmark settings.

Following this announcement, the fallback spread adjustment set by the ARRC was published by Bloomberg and effective March 5, 2021. U.S. Regulators also directed banks to stop entering into new USD LIBOR contracts, including derivatives, after Dec. 31, 2021, as it would create safety and soundness risks.

The Adjustable Interest Rate (LIBOR) Act
U.S. federal legislative solution for transitioning certain LIBOR contracts

On March 15, 2022, President Biden signed the Adjustable Interest Rate (LIBOR) Act (the “Act”) into law. The Act provides a uniform approach for replacing LIBOR as a benchmark rate in certain LIBOR contracts after LIBOR is no longer published or representative.

The Act covers contracts that either does not include effective fallback provisions, for example, because they have no provisions for a replacement benchmark rate or provisions based on dealer polls, or permit a party to select a replacement benchmark rate at its discretion. Under the Act, references to the most common tenors of LIBOR in these contracts will be replaced as a matter of law, without the need to be amended by the parties, to reference instead a benchmark rate identified by the Board of Governors of the Federal Reserve System (“the Board”) that is based on the secured overnight funding rate (“SOFR”).

On Dec. 16, 2022, the Board issued a final rule to implement the Act, which included the identified SOFR-based benchmark replacement rates for various types of contracts subject to the Act. The final rule will become effective on Feb. 27, 2023.

LIBOR is no longer representative

As of June 30, 2023, all settings of LIBOR are considered non-representative benchmark rates, including all tenors of USD LIBOR. Select currencies and tenors may be published on a synthetic and non-representative basis for a short time, per guidance from the UK’s Financial Conduct Authority (“FCA”). Still, for most purposes, LIBOR has ceased to exist.

Frequently asked questions

LIBOR was the average interest rate at which major global banks borrow from one another. It’s one of the most widely used interest rate indexes in the world for financial products, including commercial loans, bonds, debt and derivative contracts. Prior to Dec. 31, 2021, the rate was published by the IBA in five currencies (USD, EUR, GBP, JPY and CHF) and seven different maturities or time periods (overnight/spot next, one week, and one, two, three, six and 12 months). After June 30, 2023, no currencies or tenors of LIBOR are considered representative interest rate benchmarks.

LIBOR is predominantly based on rate quote submissions from panel banks. The rate-setting process has been subject to criticism, as it has become increasingly based on judgment (rather than actual market activity) and lacks transparency.

In 2017, the Alternative Reference Rates Committee (ARRC) identified SOFR as the recommended alternative to USD LIBOR. SOFR is based on transactions in the U.S. Treasury repurchase or repo market, where banks and investors borrow or lend Treasury’s overnight. The Federal Reserve Bank of New York began publishing SOFR in 2018.

Although many expect that SOFR will be the predominant replacement for LIBOR, there are other replacement rates available. The most prevalent of these rates are BSBY, AMERIBOR and Prime. You should consult with your own financial, legal and tax advisors to determine which replacement rate best suits your needs.

CSRs are generally transaction-based term rates and include an embedded term premium to compensate for maturity risk resulting from longer holding periods. CSRs include a credit risk premium that reflects bank credit risk and the cost of unsecured funding. Also, they may be based on different market segments, mostly related to bank funding.

CSRs are more like LIBOR than SOFR. Examples of CSRs are BSBY and AMERIBOR, which offer term rates and include a credit component. U.S. Bank has been operationally ready to offer BSBY Index and AMERIBOR products since July 2021.

An RFR implies that the underlying instrument from which the rate is calibrated has little to no risk. SOFR is deemed to be a risk-free rate because it is based on collateralized transactions secured by U.S. Treasury obligations.

We’re well-positioned to make the necessary changes and facilitate a smooth transition for our clients. We’ve established an enterprise-wide LIBOR Transition Office to lead our preparation for the change, including identifying, assessing and monitoring risks associated with the transition. This office, with oversight from senior leaders, is working in partnership with designated LIBOR leaders from each business area to make required changes. We’re also working closely with industry working groups and regulators to stay on top of industry developments.

We’ve made considerable progress by modifying our systems, models, procedures, and internal infrastructure to ensure operational readiness to accept alternative reference rates. We’ve also adopted the industry best practice guidelines for fallback language, ceased issuance of new LIBOR contracts in accordance with regulatory guidance, converted our cleared interest rate swaps from Fed Funds (OIS) discounting to Secured Overnight Financing Rate discounting and distributed internal and external communications on the LIBOR transition.

If you have a LIBOR-based loan and are using a LIBOR-based derivatives transaction – such as an interest rate swap – to create a fixed-rate profile, then you need to consider the impact of the end of LIBOR on both. ISDA, the derivatives industry group, published robust fallback provisions to be applied to the swap upon the discontinuation of LIBOR. The ARRC’s recommended fallback language for loans falls back to a different rate than ISDA’s recommended fallback language, which could result in a basis difference between your LIBOR loan and LIBOR swap.

U.S. Bank has adopted the ISDA protocol for its current derivative contracts. As we review existing loans, if your loan matures after the end of LIBOR, a representative from our Derivatives Product Group and your designated U.S. Bank relationship manager will reach out to you to discuss options for your loan and the associated swap.

It is a provision in the agreement for a loan, bond, derivative or another financial instrument that outlines how a contract will transition to a new interest rate upon cessation of the existing interest rate. The fallback language could specifically identify a replacement rate or simply outline the process to determine a replacement rate if the interest rate used in the contract becomes unavailable. The fallback provision typically comprises three key components: fallback trigger event, benchmark replacement rate and benchmark replacement adjustment.

Prior to U.S. regulators’ announcement regarding ceasing issuance of new LIBOR contracts after Dec. 31, 2021, the ARRC had recommended fallback provisions for syndicated and bilateral loans, floating rate notes, securitizations and residential adjustable-rate mortgages to help transition away from LIBOR when it becomes unavailable.

If you have a LIBOR-based loan, line of credit, derivative or other product, we’ll work with you to transition to an alternative reference rate. We recommend that you seek independent legal, accounting and tax advice on the amendment of existing contracts and with new products that reference alternative reference rates.

We recommend taking a proactive approach and encourage you to:

  • Identify agreements based on LIBOR that are due to mature after expected LIBOR cessation dates and understand fallback mechanisms.
  • Compare offerings that are available to you and determine which alternative reference rate(s) align with your needs.
  • Determine the economic impact of new or amended lending terms resulting from the use of new alternative reference rates, including associated interest hedging.
  • Consult with your legal, accounting, tax, and compliance teams to manage the economic effects of new and amended proposals.

ADDITIONAL RESOURCES

Alternative Reference Rates Committee

Federal Reserve Bank of New York

Financial Conduct Authority

International Swaps and Derivatives Association

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Disclosures

This discussion is intended to be informational only and is not exhaustive or conclusive. It is not intended to serve as a recommendation or solicitation for the purchase or sale of any particular product or service. It does not constitute advice and is issued without regard to any particular objective or the financial situation of any particular individual. Some of the information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Other information represents the opinion of U.S. Bank and is not intended to be a forecast of future events or a guarantee of future results. U.S. Bank and its representatives do not provide tax, accounting or legal advice. Each individual's financial situation is unique. You should consult your tax, accounting and/or legal advisor for advice and information concerning your particular situation.

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Deposit products are offered by U.S. Bank National Association. Member FDIC.

U.S. Bank is not responsible for and does not guarantee the products, services or performance of U.S. Bancorp Investments, Inc.

For U.S. Bancorp Investments, Inc.:

Investment products and services are available through U.S. Bancorp Investments, the marketing name for U.S. Bancorp Investments, Inc., member FINRA and SIPC, an investment adviser and a brokerage subsidiary of U.S. Bancorp and affiliate of U.S. Bank National Association.

Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy.

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