FAQs

The London Interbank Offered Rate (LIBOR) is calculated from submissions by selected "panel" banks¹ of the rates they either pay or would expect to pay to borrow from one another.

LIBOR is a widely-used interest rate benchmark. Rates are determined daily by the LIBOR administrator, the ICE Benchmark Administration (IBA), for various currencies (USD, EUR, GBP, CHF, JPY) and tenors (Overnight, 1w, 1m, 2m, 3m, 6m and 12m).

¹https://www.theice.com/iba/libor#methodology

Notional values reflect size of LIBOR market, except for EUR and JPY that additionally include EURIBOR and TIBOR, respectively.

Sources: ISDA, IBOR Global Benchmark Survey, 2018 Transition Roadmap, February 2018; MPG Final Report on Reforming Interest Rate Benchmarks, March 2014

According to IBA, LIBOR is used to determine periodic interest payments for many hundreds of trillions of notional of financial products globally, and is used for example in derivatives, bonds, structured products, securitised products and loans.

Just over a decade ago, the market's perception of an increase in inter-bank credit risk inherently contained within LIBOR led to a widening of the basis between LIBOR and short-term interest rate futures. Financial institutions began to switch from using LIBOR to Overnight Index Swap rate (OIS) for discounting purposes, which was seen as being closer to a risk-free rate. At the same time, liquidity in the unsecured lending market, which underpins LIBOR, declined as banks became increasingly unwilling to lend to one another on an unsecured basis. The concern was that a lending rate, based on an increasingly less liquid market, was being used to reference many multiples of financial contracts. As a result, in 2017, the FCA announced that the market should transition to alternative reference rates based firmly on transactions, with panel bank support for current LIBOR to continue for a finite length of time. 

Despite market-driven transition challenges triggered by the COVID-19 pandemic, the FCA² has stated that the transition away from LIBOR still needs to happen by the time LIBOR ceases to be available.

²https://www.fca.org.uk/news/statements/impact-coronavirus-firms-libor-transition-plans

Different jurisdictions have developed different methodologies for their new ARRs, and as illustrated in the timelines in the appendix, these are all at different stages in terms of market liquidity and development. These ARRs are managed by different administrators, as outlined below.

The ARRs are structurally different from LIBOR and are not economic equivalents.

Some of the ARRs are secured rates, i.e. calculated from observed repos collateralized by government bonds. This applies to SARON for CHF and SOFR for USD. The others are unsecured like LIBOR, i.e. based on unsecured borrowing with no actual underlying security. LIBOR differs from these unsecured ARRs in that it is based not only on observed interbank borrowing transactions but also expert judgement.

In July 2021, the Alternative Rates Reference Committee (ARRC) formally recommended the adoption of SOFR term rates. However, given that SOFR is backward looking in nature and reflects what actually did happen to interest rates overnight, it would require substantial changes in both the calculation and reporting of interest rates in order to be considered a completely like-for-like LIBOR replacement in certain key aspects.

The ARRC’s introduction of Term SOFR was intended to fill this gap. Term SOFR rates are forward-looking interest rate estimates of overnight SOFR for reference periods starting T+2 from the date of publication. They are calculated and published for one-month, three-month, six-month and 12-month tenors. The benchmark methodology includes the use of CME SOFR Futures derivatives products, which compound and annualise the daily overnight SOFR rate on the basis of an Actual/360-day count convention over the applicable reference period. Term SOFR, like other RFR term rates, reflects market expectations on the future movement in the SOFR rate over a reference period. Like RFRs and other RFR term rates, and in contrast to LIBOR, it does not contain any credit sensitivity component or term liquidity premium.

a) Immediately after 31 December 2021, the following USD LIBOR settings permanently ceased: 
        - the 1W and 2M USD LIBOR settings.
b) Overnight, 1M, 3M, 6M, and 12M USD LIBOR settings will continue to be calculated using panel bank submissions until June-2023

We would encourage you to assess the impact of the cessation or permanent unrepresentativeness of the LIBOR Settings on your portfolio and to take appropriate independent professional advice (legal, tax, accounting, financial or other).

The below table provides a summary  of each USD LIBOR setting, and its respective last publication on a representative or non-representative basis (as applicable):

Derivatives and other securities are often valued by discounting expected cashflows back to their present value using a discounting rate. The impact of a change of discounting rates on the valuation is referred to as Discounting Risk. Prior to the financial crisis, the rate used to discount cashflows in the derivatives market was LIBOR. Subsequently, many market participants adopted an approach that aligned the discounting rate used with the interest rate paid (cash margin rate) on the type(s) of collateral specified (known as Eligible Collateral) in the underlying Credit Support Annex (CSA). As such, any change to the discounting curve will not only change the Discounting Risk but also create a value transfer. 

Trillions of dollars’ worth of derivative contracts were either executed bilaterally between market participants under ISDAs (and if collateralized, with a CSA) or intermediated by Central Clearing Counterparties (CCPs). Many of these bilateral CSAs reference Effective Federal Funds Rate (EFFR) or EONIA as the benchmark used to determine the interest paid on cash collateral posted. The CCPs have switched to using SOFR (from EFFR) to determine the margin interest rate (known as Price Aligned Interest⁵ (PAI) rate) for USD activity and €STR (from EONIA) for PAI for EUR activity.

London Clearing House (LCH) and Chicago Mercantile Exchange (CME) have adopted SOFR in place of EFFR and €STR in place of EONIA as the PAI rate and discounting rate for all USD and EUR discounted contracts held in the exchange. In order to minimize the resulting discounting basis risk, it is expected that some market participants will seek to renegotiate their bilateral CSAs referencing EFFR to SOFR following these switches.

⁶https://www.cftc.gov/media/2421/MRAC_LCHSOFRDiscountingLetter090919/download

⁷https://www.cmegroup.com/education/articles-and-reports/sofr-price-alignment-and-discounting-proposal.html

The change in CCPs’ PAI for cleared swaps has had a corresponding impact on swaptions that reference the price of cleared swaps as the underlying instruments. UBS has evaluated the contractual terms of the relevant ISDA Supplements related to swaptions7 and is willing to discuss any changes to existing portfolios where required to incorporate latest market standards.

⁹https://www.ecb.europa.eu/pub/pdf/other/ecb.recommendation_swaptions_impacted_by_discounting_switch_to_EuroSTR~a64f042ed9.en.pdf

¹⁰https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-swaptions-recommendations.pdf

EFFR will continue to be published. Although EFFR is an IOSCO-compliant rate, the ARRC has publicly acknowledged that it has certain shortcomings (e.g. a relatively small underlying market and limited set of underlying transactions/counterparties) and the ARRC therefore determined not to recommend EFFR or the Overnight Bank Funding Rate (OBFR) as the replacement rate for USD-LIBOR. See ARRC FAQs for further information.

LIBOR is widely applied as the floating interest rate benchmark referenced in a derivative (such as a swap floating leg), coupon on a bond or used to determine the interest rate on a loan. The valuation of such contracts or securities is driven by the change in the expected value of LIBOR—this is expressed as Forecasting Risk.

Active LIBOR transition is where market participants switch out of LIBOR referenced contracts into ARR referenced contracts as market liquidity allows, rather than waiting until the end of 2021. This activity would see ARR forecasting risk gradually replace LIBOR forecasting risk.

The ARR forecasting curve is generally lower than the LIBOR equivalent.

For any contracts referencing LIBOR when it is discontinued, the parties will, in the absence of changes to the terms, have to rely on the contractual terms that exist to determine the post-cessation rate. The effectiveness and prevalence of these fallback provisions varies across products and markets. These provisions, depending on when drafted, may have the components listed in the following table. Market participants should review existing LIBORreferencing financial contracts (that are expected to be held beyond the date by which LIBOR is no longer available) for provisions that determine the reference rate in the absence of LIBOR, or confirm the steps to be taken to frame an alternative. Various industry groups have provided fallback language for impacted financial products addressing permanent LIBOR cessation.

Clients should consider the economic and financial impact of the fallback provisions in their own contracts.

For example, the Federal Reserve Bank of New York's Alternative Reference Rate Committee has published language for cash products such as securitized products and loans. The Loan Market Association has also published fallback documentation for loans. ISDA published the updated ISDA Definitions on 23 October 2020 which become effective on 25 January 2021.

The preference of the FCA⁸ is for market participants to pro-actively switch to new ARRs as soon as possible (as a primary approach), rather than to rely on fallback language (acting, in effect as a ‘seatbelt’). However, there are various aspects which may hinder this process; for example, liquidity in an ARR.

¹¹ https://www.fca.org.uk/news/speeches/libor-preparing-end

There are different defined triggers and fallbacks for different products. In older bond documentation that did not foresee LIBOR cessation, for example, a common fallback is to use the last available published rate. Thus, in the event of LIBOR cessation, these securities would essentially become fixed rate products. In loans, a common ultimate fallback is to lenders' costs of funds. In a derivative, on the other hand, the alternative to LIBOR may be subject to calculation by agents (e.g. a dealer poll undertaken by a calculation agent).

ISDA published the 2020 IBOR Fallbacks Supplement and Protocol on 23 October 2020. The new fallbacks became effective for existing derivative contracts from 25 January 2021 where both counterparties have adhered to the Protocol or bilaterally implemented the Supplement prior to that date. Where one or both counterparties adhere to the Protocol after this date, the new fallback provision will become effective for contracts entered into before 25 January 2021 on the date the second counterparty adheres, or if the Supplement is implemented bilaterally from the date that is agreed.

The ISDA Protocol has been drafted deliberately broad to cover transactions governed by ISDA Master Agreement or other forms of master agreement (e.g. Federation Bancaire Francaise, Swiss Master Agreement).

If market participants choose not to sign up to the Protocol or do not adopt the provisions through a bilateral negotiation then the existing contracts will remain on the current fallback provisions as stipulated in the contract which when written probably did not envisage a permanent cessation of LIBOR. UBS encourages market participants to evaluate whether the Protocol is appropriate for their portfolios.

ISDA's Benchmark Supplement also provides the option to implement a contractual process for existing contracts. However, both parties to the contract need to elect to implement the Supplement for existing contracts in order for this to take effect.

It should be noted that even in ARRs where liquidity and volumes are most developed (e.g. SONIA), this is currently concentrated in linear derivatives such as swaps. For other types of products such as non-linear derivatives or cross currency derivatives there is currently little liquidity and volumes and market standards are still evolving. It should be noted that in these products, reliance on the ISDA Fallback Protocol to achieve transition may result in an outcome that is not aligned to the new market standards

Failing to amend your IBOR impacted contracts may lead to unintended economic and operational consequences: existing fallback terms may not address permanent discontinuation and could lead to large economic value changes, or introduce operational complexity.

You should review your portfolio carefully and consider seeking independent professional advice as appropriate (legal, tax, accounting, financial or other).

UBS has implemented an IBOR transition programme  and remains focused on identifying and addressing the transition impact to our operational capabilities and financial contracts, among others.

UBS is remediating legacy IBOR-impacted contracts prior to the relevant cessation dates and in line with regulatory guidance. We are actively engaged with clients in relation to IBOR reform, through a variety of initiatives such as webinars, client outreaches and client conversations on transition of impacted products. We are keen to support our clients by helping to facilitate their transition plans and continue to develop our product offerings to ensure we are able to offer a full range of transition solutions.

For derivatives, ISDA updated the 2006 ISDA Definitions on 25 January 2021, to introduce fallback provisions using ARRs for the key IBORs, . These fallbacks are therefore now incorporated into all new derivative transactions referencing the 2006 ISDA Definitions. Parties can also incorporate these fallbacks into impacted derivatives entered into prior to that date by adhering to ISDA’s IBOR Protocol or by agreeing bilaterally to incorporate the new fallbacks into documentation.

On June 15, 2022, ISDA published a standalone Form of Agreement for adoption of USD LIBOR ICE Swap Rate Fallback Provisions in Confirmations for legacy transactions incorporating either the 2000 ISDA Definitions, the 2006 ISDA Definitions or the 2021 ISDA Interest Rate Derivatives Definitions or Confirmations referencing the “USD LIBOR ICE Swap Rate.”

For cash products, the ARRC has provided recommended fallback language for USD LIBOR-referencing contracts across a range of different asset classes, including loans, securitisations and floating rate notes (all available on the ARRC Fallback Contract Language webpage: (all available on the ARRC Fallback Contract Language webpage: https://www.newyorkfed.org/arrc/fallbacks-contract-language). Specifically for loans, the LSTA and LMA have provided standardised fallbacks.

You should review your documentation closely to determine the position for each contract in your portfolio, in relation to existing or legacy products, as well as for any new products you are considering entering into.