Market Updates on the LIBOR Transition

This article is reprinted from the Indexology blog of S&P Dow Jones Indices.

This year will be key in the London Inter-Bank Offered Rate (LIBOR) transition. After consultation on ending the publication of LIBOR in USD, GBP, EUR, CHF, and JPY, the administrator of LIBOR, the ICE Benchmark Administration (IBA), may announce its decision soon. The announcement of LIBOR cessation would trigger the spread adjustment to be fixed as a component of the LIBOR fallback rate for derivatives contracts with fallback provisions governed by ISDA.1 For legacy non-consumer cash products referencing USD LIBOR, this fixed spread adjustment would be added to a form of SOFR to replace USD LIBOR as recommended by the ARRC.2

IBA’s consultation in December 2020 indicated its intention to cease the publication of LIBOR in GBP, EUR, CHF, and JPY, as well as 1-week and 2-month USD LIBOR at the end of 2021, along with major USD LIBOR tenors (overnight, 1-month, 3-month, 6-month, and 12-month) in June 2023. Despite the potential delay of USD LIBOR cessation to mid-2023, U.S. regulators are encouraging no new USD LIBOR contracts after the end of 2021, while allowing most legacy contracts to mature before USD LIBOR stops.

On derivatives contracts, progress has been made in LIBOR transition with the ISDA 2020 IBOR Fallbacks Protocol having taken effect on Jan. 25, 2021. The ISDA leads the initiative to improve the derivatives contract robustness to address the risk of LIBOR discontinuation. The ISDA’s protocol provides standard fallback language for IBOR-based derivatives (including LIBOR) on a voluntary basis. It lays out a clear path to transition to replacement rates for the USD 200 trillion USD LIBOR derivatives market.

The other milestone in listed derivatives’ LIBOR transition also took place on Jan. 25 when CME provided details on proposed methodology for transitioning Eurodollar futures and option contracts. Because of Eurodollar futures and options’ close relation to OTC LIBOR-based derivatives, CME aligns with ISDA in its Eurodollar futures and options fallback language. Upon a fallback trigger, Eurodollar futures would be converted to 3-month SOFR futures, with prices adjusted in line with the ISDA approach. Eurodollar futures options would be replaced with corresponding 3-month SOFR options, with strike adjusted using ISDA’s spread adjustment.

On cash products, the ARRC has recommended fallback language for floating-rate notes, bilateral business loans, syndicated loans, and saucerization products for market participants’ voluntary use. For contracts that do not have fallback language or that fall back to a rate based on LIBOR, the ARRC-proposed LIBOR transition legislation was included in the New York State 2022 budget and presented in January 2021. As many cash products referencing USD LIBOR fall under New York law, the proposed legislation will help contracts make an orderly switch to replacements when LIBOR ends.

¹ The International Swaps and Derivatives Association (ISDA) is a trade organization of participants in the market for over-the-counter derivatives. It is headquartered in New York City, and has created a standardized contract to enter into derivatives transactions.

² The Alternative Reference Rates Committee (ARRC) is a group of private market participants convened by the Federal Reserve Board and the New York Fed to help ensure a successful transition from U.S. dollar LIBOR to a more robust reference rate, its recommended alternative, the Secured Overnight Financing Rate (SOFR).

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