Transitioning
From LIBOR
The London Interbank Offered Rate (LIBOR) interest benchmark has changed. It’s a rate at which major global banks lend to one another in the international interbank market for short-term loans. Historically it has been used as an interest benchmark for financial contracts including derivatives, bonds and loans globally. In 2021 the Financial Conduct Authority (FCA) announced that most LIBOR interest benchmarks would cease to be published after 31 December 2021. This means that representative LIBOR rates are no longer available for Sterling, Euro, Swiss Franc and Japanese Yen. Representative rates will continue to be published for US Dollar until June 2023.
In the UK, an industry led Working Group, including the Bank of England and the FCA, was established to develop alternative rates to replace sterling LIBOR and oversee the transition. The Working Group recommended the Sterling Overnight Index Average (SONIA) as its preferred alternative reference interest rate for sterling transactions (although it is possible to transition to other rates as well). Similarly, globally, where LIBOR is used for financial contracts in other currencies, including in the US, Euro Area, Switzerland and Japan, alternative interest rate benchmarks have also been nominated.
The decision to transition away from LIBOR was taken in order to remove reliance on unsustainable LIBOR rates and build a more robust foundation for the financial system.
We now use SONIA or the Coutts Base Rate (which is a published rate based on the base rate set and published by the Bank of England) for commercial borrowing. For all other borrowing, the Coutts Base Rate for sterling facilities and Central Bank Rates for other currency facilities are offered as simpler and more familiar rates to replace LIBOR.
Please visit the Bank of England's website for more details about the UK’s progress.
WHAT DOES THIS MEAN FOR ME?
If you have any borrowing or financial contracts that use a LIBOR interest benchmark rate, we will have contacted you about our proposed approach and the transition to the use of the alternative rates detailed above, when relevant LIBOR rates cease to be available (including the relevant changes to your terms). Once we have completed your transition, we will write to you to confirm that the transition to an alternative rate has taken place.
If you have investment funds or portfolios, that use LIBOR interest benchmark rates. The issuers of the assets will be responsible for reviewing these assets and taking the appropriate action.
If you have any questions about this transition, please do contact your Relationship Manager who’ll be happy to help.
Alternatively, you may wish to seek advice from an independent professional advisor, such as an accountant or lawyer, to help assess what the changes may mean for you.
Further information from the FCA on the end of LIBOR is available here
WHAT IS LIBOR?
The London Interbank Offered Rate (LIBOR) is one of a number of Interbank Offered Rates (IBORs) that are widely used in the global financial markets.
It was used as a key interest rate benchmark across a number of derivatives, bonds, loans, securitisations, deposits and other products, as well as for banks and other financial institutions own funding and capital needs.
Historically, LIBOR was calculated and published daily across five currencies (GBP, USD, EUR, JPY and CHF) and seven maturities (overnight, one week, and 1, 2, 3, 6 and 12 months) by the Intercontinental Exchange Benchmark Administrator (ICE BA). It was based on submissions by a panel of banks using available transaction data and their expert judgement.
LIBOR should provide an indication of the average rate at which each LIBOR contributor could borrow unsecured funds in the London interbank market for a given period, in a given currency.
This average was published and used by the financial markets.
LIBOR provides forward looking ‘term rates’ which includes an element of credit spread reflecting the borrowing risk in the interbank market. It provides a known interest rate and amount of interest due at the end of the borrowing term, something that some clients may find helpful for cash flow forecasting.
International regulators began focussing on LIBOR reform from 2013. With the number of interbank unsecured borrowing transactions reducing in recent years, there has been an increasing reliance on the expert judgement of panel banks on which to base LIBOR.
This led to concerns that LIBOR was no longer a representative or reliable benchmark reference rate. From the beginning of 2022, the global financial markets have started transitioning away from using interbank offered rates in financial contracts.
"The absence of active underlying markets raises a serious question about the sustainability of the LIBOR benchmarks that are based upon these markets… the planning and transition must now begin."
Andrew Bailey, Chief Executive Officer, FCA
This link provides an at a glance view of the key dates that the regulator has set for financial institutions to transition to alternative rates.
SONIA - AN OVERVIEW
LIBOR is a forward-looking term rate. However, SONIA (Sterling Over Night Indexed Average) is a backward-looking, overnight rate based on actual transactions that have taken place the day before. It is set in arrears and based on actual transactions in overnight indexed swaps for unsecured transactions in the Sterling market. SONIA is a risk-free rate meaning no bank credit risk is included. It is expected to replace GBP LIBOR across global financial markets by the end of 2021.
Each London business day the SONIA fixing is calculated as the weighted average rate of all unsecured overnight sterling transactions brokered in London by Wholesale Markets Brokers’ Association (WMBA) members between 12am and 3.15pm London time in a minimum deal size of £25m.
SONIA is not a term rate and does not provide up-front certainty of the amount of interest due at the end of the interest period. Instead, it is an overnight rate, based on actual market rates and reset on a daily basis in arrears; this removes any expectation of future events inherent in a forward-looking term rate. It is likely to be a less volatile rate known only at the end of the borrowing term. It also lacks any interbank credit premium and as a result is far more stable than LIBOR, historically tracking very close to Central Bank Base Rates. Some clients may favour this rather than a more volatile term rate known at the start of the borrowing term.
As the rate resets daily and as there is no mechanism to settle interest daily the SONIA rate is compounded on a daily basis. To allow some notice ahead of interest settlement, a five-day rate set lookback period has been developed meaning we are able to calculate and send you the interest due amount at least five days prior to settlement.
There is some industry discussion about the possibility of creating a forward-looking “term SONIA” rate. However, the potential scope of where such a rate may be preferable, the methodology for its creation, and the timing of its introduction, all remain uncertain. The advice from the FCA is that firms should not wait for, or rely on, the development of any potential term SONIA rate.
Further details about SONIA can be found here.
CENTRAL BANK RATES
Whilst SONIA is the recommended replacement for LIBOR, due to the complexities of how SONIA is calculated, we offer this rate for commercial borrowing. For all other borrowing, the Coutts Base Rate for sterling facilities and the following Central Bank Rates for other currency facilities are offered as simpler and more familiar rates to replace LIBOR:
(a) Sterling (GBP): the Coutts Base Rate
(b) United States Dollars (USD): the Federal Reserve discount rate
(c) Euro (EUR): the European Central Bank refinancing rate
(d) Japanese Yen (JPY): the Bank of Japan base rate
(e) Swiss Franc (CHF): the Swiss National Bank policy rate
The Coutts Base Rate is a published rate based on the base rate set and published by the Bank of England. The other rates above are set and published by the relevant Central Banks.
For more information about specific facilities and any other products that we offer, please contact your Relationship Manager who will be happy to help.
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