LIBOR transition update

The Financial Conduct Authority (FCA) of the United Kingdom has confirmed cessation or loss of representativeness of all the 35 LIBOR benchmark settings, which effectively means that market participants should move away from LIBOR and determine alternative reference rates for all financing which continues beyond year-end 2021. In order to prepare for the cessation of LIBOR the European Council has opted for legislative fix for LIBOR and has adopted amendments to the Benchmark Regulation (EU) 2016/1011 giving the European Commission power to designate statutory successor to LIBOR in certain cases in order to deal with so called tough legacy contracts, which do not provide for suitable fallback provisions.

LIBOR transition has been a hot topic since the Financial Conduct Authority (FCA) of the United Kingdom announced in summer 2017 that after 2021 it will no longer persuade LIBOR panel banks to submit the rates required in order to calculate LIBOR. In our previous LIBOR article published in February 2021 we shortly explained the basis of and the inherent risks relating to IBORs (interbank offered rates) and the proposal to transition to the use of risk free rates. In this article we give a brief status update on the LIBOR transition.

Announcement of cessation of LIBOR by FCA

On 5 March 2021 the FCA announced the future cessation or loss of representativeness of all the 35 LIBOR benchmark settings currently published by ICE Benchmark Administration (the "Announcement"). By benchmark settings the FCA means the different tenors provided for different LIBOR currencies. Permanent dates for end of publications were set out for 26 LIBOR settings as follows:

  1. immediately after 31 December 2021 publication of all 7 euro LIBOR settings, all 7 Swiss franc LIBOR settings, the Spot Next, 1-week, 2-month and 12-month Japanese yen LIBOR settings, the overnight, 1-week, 2-month and 12month sterling LIBOR settings, and the 1-week and 2-month US dollar LIBOR settings will cease; and
  2. immediately after 30 June 2023 publication of the overnight and 12-month US dollar LIBOR settings will cease.

All the remaining 9 LIBOR settings will lose their representativeness after 31 December 2021 or 30 June 2023 (as applicable), but sterling LIBOR settings (1month, 3-month and 6-month) and yen LIBOR settings (1month, 3-month and 6-month) may continue to be published on a synthetic basis following 31 December 2021, and US dollar LIBOR settings (1month, 3-month and 6-month) may continue to be published on a synthetic basis following 30 June 2023.

LIBOR settings published on synthetic basis will no longer be representative of the underlying market and the economic reality the setting is intended to measure, and these publications on a synthetic basis would be intended to assist holders of so called "tough legacy contracts". According to FCA tough legacy contracts are those contracts where there is genuinely no realistic ability to renegotiate or amend the contract to reference to a non-LIBOR rate or amend to add fallbacks that would operate when LIBOR is discontinued. Other than the vague definition above, there is currently no clear guidelines as to which contracts these would be, but the FCA is expected to provide further consultation later this year. The expectation seems to be that only a very limited number of financial contracts would fall under this category. The FCA reminded in connection with their Announcement that new use of this synthetic LIBOR by UK regulated firms in regulated financial instruments would be prohibited under the UK Benchmarks Regulation.

EU's legislative amendment for cessation of LIBOR

On the other hand, in order to cope with so called tough legacy contracts and to provide certainty for market participants, the European Council has adopted amendments to the Benchmark Regulation (EU) 2016/1011 (the "EU BMR"), which entered into force on 13 February 2021. Based on the amendments to the EU BMR, the European Commission was given the power to replace so-called 'critical benchmarks', which could affect the stability of financial markets in the EU, and other relevant benchmarks, if their termination would result in a significant disruption in the functioning of financial markets in the EU. Further, the European Commission can replace third-country benchmarks if their cessation would result in a significant disruption in the functioning of financial markets or pose a systemic risk for the financial system in the EU. The European Commission may exercise its powers to designate a replacement rate upon occurrence of certain triggering events, including the cessation of a benchmark or statement of non-representativeness from the relevant regulator meaning that cessation of LIBOR and/or conversion to synthetic LIBOR settings may trigger these new powers.

Following a triggering event, the replacement benchmark above designated by the European Commission would then replace references to such benchmark (in respect of which a triggering event has occurred) in:

  1. EU law governed contracts that reference a benchmark (in respect of which a triggering event has occurred); and
  2. non-EU law governed contracts where contracting parties are EU entities and applicable third country law does not provide for the orderly wind-downs of that benchmark (in respect of which a triggering event has occurred),

provided that the relevant contract does not include:

  1. a fallback provision for that benchmark; or
  2. a suitable fallback provision, meaning that there is no permanent replacement for the benchmark that is the subject of cessation, its application requires consent from third parties that has been denied, or application of the agreed replacement benchmark could have an adverse impact on financial stability.

Therefore, statutory succession of LIBOR may be decided by the European Commission, which will then by operation of law be applicable to certain tough legacy contracts as set out above.

Also, in the US legislative remedies to replace the relevant LIBOR in tough legacy contracts and instruments by the operation of law are being prepared. How these legislative remedies in the EU and in the US will interact with each other and the use of synthetic LIBOR in the UK remains to be seen.

Future use of LIBOR, STIBOR and EURIBOR

When it comes to the provision of new LIBOR loans, the Working Group on Sterling Risk-Free Reference Rates[1] has recommended that market participants should cease to initiate by the end of Q1 2021 new sterling LIBOR-linked loans that mature after the end of 2021. Despite of the fact that overnight and 1, 3, 6 and 12 months USD LIBOR settings will continue to be published until 30 June 2023, the Alternative Reference Rates Committee[2] has stated that that market participants should already be using language that provides for an automatic switch from LIBOR to a replacement benchmark in new loan agreements (or should start immediately) and that 30 June 2021 should be the target for the cessation of new USD loans based on USD LIBOR.

EURIBOR and STIBOR are the most widely used reference rates in the Swedish finance markets. Despite of the publication of all euro LIBOR settings ceasing on 31 December 2021 there are no decisions made in respect of EURIBOR ceasing to be published, and thus, market participants can continue to refer to EURIBOR as the relevant benchmark when funding in euro. Further, SEK is not a LIBOR currency and there are no decisions made in respect of cessation of STIBOR. However, as we wrote in our previous article, EURIBOR and STIBOR contain the same inherent problems as LIBOR rates, and thus, the relevant central banks may consider transitioning to suitable replacement rates also in respect of these rates at some point.

[1] A working group of market participants formed to catalyse the transition from the interest rate benchmark LIBOR towards SONIA in sterling markets.

[2] A group of private-market participants convened by the Federal Reserve Board and the New York Fed to help ensure a transition from USD LIBOR to SOFR.