LIBOR Transition A practical guide December 2020 Edition - UBS
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx LIBOR Transition A practical guide December 2020 Edition December, 2020 1
SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
Table of Contents
1. LIBOR Transition: Executive Summary_______________________________________________ 4
What does this document seek to do? _________________________________________________ 4
Summary _________________________________________________________________________ 4
Practical considerations checklist ______________________________________________________ 4
Key highlights _____________________________________________________________________ 4
What's next? ______________________________________________________________________ 4
2. LIBOR Transition: Facts and Figures _________________________________________________ 5
What is LIBOR? ____________________________________________________________________ 5
Where is LIBOR used? _______________________________________________________________ 5
What is happening to LIBOR and by when? _____________________________________________ 5
What has the response been to date? __________________________________________________ 6
What are the main Alternative Reference Rates? _________________________________________ 6
How do these ARRs differ to LIBOR? ___________________________________________________ 8
Are these ARRs secured or unsecured? _________________________________________________ 8
Will the ARRs have forward looking term structures? _____________________________________ 8
What are ARR Compounded Index Rates? ______________________________________________ 8
What about the other IBOR Benchmark Rates? __________________________________________ 9
Summary and Practical Considerations _________________________________________________ 9
3. LIBOR Transition: Discounting Risk ________________________________________________ 10
What is discounting risk? ___________________________________________________________ 10
What changes have the CCPs made? _________________________________________________ 10
What are the implications for CSAs? __________________________________________________ 10
Why will these changes drive an increased Bilateral Negotiation of CSAs? ___________________ 10
When will UBS be ready to open CSA negotiations? _____________________________________ 11
What is the impact on swaption contracts? ____________________________________________ 11
Summary and Practical Considerations ________________________________________________ 11
4. LIBOR Transition: Forecasting Risk _________________________________________________ 12
What is Forecasting Risk? ___________________________________________________________ 12
What are the Fallback Provisions? ____________________________________________________ 12
What are some examples of differing fallback methods? _________________________________ 13
How will the LIBOR transition affect new contracts executed under the updated ISDA Definitions?13
How will the LIBOR transition affect the existing contracts? _______________________________ 13
2SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
What is expected to happen to cleared contracts? ______________________________________ 14
How will the LIBOR transition affect products other than OTC derivatives? __________________ 14
How could hedge effectiveness across asset classes via linked transactions be affected by the LIBOR
transition? _______________________________________________________________________ 14
What is the ISDA LIBOR to ARR adjustment? ___________________________________________ 14
What are the ARRC's recommended best practices? _____________________________________ 14
What is Pre-Cessation? _____________________________________________________________ 15
What is 'Synthetic LIBOR'? __________________________________________________________ 15
What are the implications of 'Synthetic LIBOR' on Transition? _____________________________ 15
What are the latest expected publication dates for LIBOR?________________________________ 16
Why is the Transition challenging for certain products? __________________________________ 16
Why might these Forecasting Risk changes drive increased bilateral/ multilateral negotiation? __ 16
What are the main drivers that may determine the impact on Forecasting Risk? ______________ 16
Summary and Practical Considerations ________________________________________________ 17
5. Regulatory and Market Milestones ________________________________________________ 18
6. Regulatory and Market Milestones Continued ______________________________________ 19
7. Appendix _______________________________________________________________________ 20
ARRC Recommended Best Practices __________________________________________________ 20
FINMA’s Recommendations and Transition Roadmap for 2021 ____________________________ 21
BoE RFR Working Group - Revised target milestones to manage transition away from Sterling
LIBOR linked products by end 2021 ___________________________________________________ 23
Other IBORs Benchmark Rates _______________________________________________________ 25
Overnight Index Swap Industry Definitions _____________________________________________ 28
ARR detailed information ___________________________________________________________ 28
8. Bibliography ____________________________________________________________________ 29
9. Glossary ________________________________________________________________________ 31
10. Disclaimer _______________________________________________________________________ 32
11. Contact information _____________________________________________________________ 33
3SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
1. LIBOR Transition: Executive Summary
What does this document seek to do?
This guide aims to give UBS clients an understanding of the LIBOR transition and highlights the practical
considerations that should be taken into account. This communication is not sent to you in connection with any
wealth management, corporate or institutional client or asset management relationship you may have with UBS.
Summary
Regulators have announced that the market should stop relying on LIBOR. Each of the Alternative Reference Rates
(ARRs) for the five major currencies (USD, EUR, GBP, CHF, JPY) involved is at a different stage in terms of
development and liquidity. Other currencies' alternative rates are also being developed but the initial focus has
been on these five. The industry needs to understand, prepare and execute with respect to this market change.
LIBOR is used as a reference rate in a multitude of products and links, for example between a derivative and an
underlying asset, need to be considered in order to understand potential basis risk between LIBOR and the new
ARR. In addition to migration of transactions, industry changes in discounting methodology are underway and
changes in technology systems may be required.
UBS aims to keep clients informed of these changes and is running an extensive internal change programme
focussed on this transition. Note that EURIBOR and TIBOR are expected to remain in the medium term so industry
focus is on the other rates.
Practical considerations checklist
• Understand what this change means for you:
– Analyse the exposure you currently have to LIBOR and assess the potential financial impact
– Ensure you know where you have transactions which you believe to be linked (see Forecasting Risk Section)
– Review the fallback language in your Legal Documentation (see Forecasting Risk Section)
• Review your readiness:
– Evaluate whether you need to make any changes to your risk management systems
– In addition, consider any operational processes you may need to update, for example ensuring all reference
data sources are updated accordingly
– Consider consolidating your LIBOR exposure to reduce the number of bi-lateral transitions required
Key highlights
Facts and Figures Discounting Risk Forecasting Risk
• 5 ARRs have been identified • Discounting rate and interest paid • Updated ISDA Definitions and IBOR
to replace the 5 LIBOR on collateral usually aligned Fallbacks Protocol were published
currencies • CCPs have now switched 23 October 2020 and become
• Each ARR is an overnight rate discounting rates to ARRs and this effective on 25 January 2021
• The ARRs are backward is likely to be a key driver for • Differences in fallback methodology
looking rates increased adoption of ARRs across different product types may
• Adjustment methodology across the industry impact hedge effectiveness across
agreed to address the • Any changes to the margin annex transactions believed to be linked
differences (term and credit) for a derivative contract should • Evaluation of current contractual
between LIBOR and ARRs reference the new ARR to replace fallback provisions may lead to
existing cash margin rate increased bilateral discussion
What's next?
When relevant, UBS will be contacting you in due course on the following topics:
• Trades with UBS referencing LIBOR;
• Contracts with UBS which reference a transitioning benchmark
If you have any further questions, in the first instance please contact your sales representative. Alternatively, please
get in touch via UBS-IB-LIBOR@ubs.com.
4SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
2. LIBOR Transition: Facts and Figures
What is LIBOR?
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).
Where is LIBOR used?
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.
What is happening to LIBOR and by when?
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.
1 https://www.theice.com/iba/libor#methodology
2 https://www.fca.org.uk/news/statements/impact-coronavirus-firms-libor-transition-plans
5SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
What has the response been to date?
In response to these concerns on LIBOR, the Financial Stability Board's (FSB) review produced the basis for the 19
principles developed by the International Organization of Securities Commissions (IOSCO) 3. One of the key IOSCO
principles was that a new "representative" benchmark reference rate should wherever possible be based on
transactions and not expert judgement.
Since the initial FCA statement in 20174, national working groups (see Forecasting Risk section) have been set up
with the support of regulators and central banks with broad industry and market representation. These working
groups have recommended alternative benchmarks for each of the LIBOR currencies. These alternatives are viewed
as more robust benchmarks, compliant with IOSCO principles and are underpinned by larger volumes of observable
transactions.
It is expected that alternative reference rates (ARRs) with compounding in arrears will be a common feature of
trades in the future. It is also expected that a term rate variation will also become available for SONIA and SOFR.
What are the main Alternative Reference Rates?
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.
Underlying
Legacy transactions
Reference Secured vs Rate
Jurisdiction Working Group Rate Target ARR Unsecured Administrator Comments
US Alternative USD LIBOR Secured Secured Federal Reserve There are
Reference Rates Overnight Bank of ongoing
Committee Financing Rate New York discussions
(ARRC) (SOFR) regarding a credit
sensitive index for
the US market
UK Working group GBP LIBOR Sterling Unsecured Bank of England
on Sterling Risk- Overnight Index
Free Reference Average (SONIA)
Rates
Euro Area Working Group EONIA1 Euro Short Term Unsecured European Reformed
on Euro Risk- Rate (€STR) Central Bank EURIBOR is
Free Rates expected to
continue
alongside €STR
as a multiple rate
approach. The
European
Commission has
expressed
confidence in
EURIBOR for the
medium term
Switzerland The National CHF LIBOR Swiss Average Secured SIX Swiss
Working Group Rate Overnight Exchange
on Swiss Franc (SARON)
Reference Rates
3 https://www.iosco.org/library/pubdocs/pdf/IOSCOPD415.pdf
4 https://www.fca.org.uk/news/speeches/the-future-of-libor
6SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
Underlying
Legacy transactions
Reference Secured vs Rate
Jurisdiction Working Group Rate Target ARR Unsecured Administrator Comments
Japan Cross-Industry JPY LIBOR Tokyo Overnight Unsecured Bank of Japan Multi rate
Committee on Average Rate approach
Japanese Yen (TONA) planned with
Interest Rate TIBOR (but
Benchmarks Euroyen TIBOR
may discontinue)
Note:
1 This is not an IBOR, however it is being replaced by an ARR. EUR LIBOR has not been referenced as its role as a benchmark is dwarfed by the
use of EONIA or EURIBOR.
Please see the Appendix for ARR detailed Information.
7SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
How do these ARRs differ to LIBOR?
The ARRs are structurally different from LIBOR and are not economic equivalents.
Components LIBOR ARRs
Methodology Based on a waterfall methodology SOFR, SONIA, €STR, SARON and TONA are
incorporating real transactions but also anchored in real transactions
expert judgement
Term Published for 7 maturities from overnight up Currently only available overnight, however note
to one year that central banks and SIX have begun to publish
indices to limit the amount of daily compounding
calculations required for market participants
Credit Risk Includes a risk adjustment to account for There is minimal credit spread adjustment as the
Adjustment interbank credit spread and tenor ARRs are overnight rates and some ARRs are
secured
Rate The rate is set at the beginning of the period The rate is based on daily observations and is
only known at the end of the period
Settlement Paid at end of period There are a variety of conventions used in the
Conventions calculation of cashflows dependent on backward
looking rates:
• Compounding of the overnight ARR over the
payment period
• Averaging of the overnight ARR over the
payment period
• Lockout
• Backward Shift or Lookback
Please see Appendix Overnight Index Swap
Industry Definitions for further information on
the above
These differences may mean market participants’ risk management systems might require enhancements to
manage the different conventions which are used to calculate payments.
Are these ARRs secured or unsecured?
Some of the ARRs are secured rates, i.e. calculated from observed repurchase agreements (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 as it is
based not only on observed interbank borrowing transactions but also expert judgement.
Will the ARRs have forward looking term structures?
The ARRs developed to-date are overnight rates. There are ongoing efforts to develop forward looking term
structures for the ARRs (except for SARON), the most advanced of these is in SONIA where there is sufficient depth
in the ARR derivatives market in order to be able to calculate the rate. It is also expected that a SOFR term rate will
be available for use by mid-2021.
What are ARR Compounded Index Rates?
An alternative to forward-looking term structures is to provide the result of compounding a rate over a period (such
as 30, 90, 180 days) and publishing these as indices. This action may assist some market participants to adopt these
rates as it can limit the amount of daily compounding calculations required.
Currently these indices are being published for SOFR by the Federal Reserve, SARON by the SIX Swiss Exchange &
SONIA by the Bank of England.
8SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
What about the other IBOR Benchmark Rates?
The initial focus has been on the five ARRs detailed above. In due course other alternative rates may be developed.
See Appendix Other IBORs Benchmark Rates for selected examples of those currently under review.
Summary and Practical Considerations
Below are some of the practical considerations clients should take into consideration for this LIBOR transition
Summary Practical Considerations include
• 5 ARRs have been identified to replace the 5 LIBOR • Evaluate whether you need to make any changes to
currencies your risk management systems, specifically to ensure
that you are able to trade, manage and settle
• The ARRs are currently only overnight rates; term
transactions referencing a backward looking
rates may become available in some currencies in the
compounded (or simple averaged) rate as opposed
future
to a forward looking term rate
• The ARRs are generally published the following day
• The methodology to calculate an adjustment to
replace LIBOR with an ARR (to address the term and
credit differences) has been agreed by ISDA
If you have any further questions, in the first instance please contact your sales representative. Alternatively,
please get in touch via UBS-IB-LIBOR@ubs.com.
9SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
3. LIBOR Transition: Discounting Risk
What is discounting risk?
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.
What changes have the CCPs made?
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.
What are the implications for CSAs?
To reflect the eligible collateral, the current overnight benchmarks for the major currencies are used to pay PAI. For
example, EFFR is used as the PAI rate on the posting of USD cash collateral for the majority of bilateral CSAs. This
rate is generally used as the discount rate to value the trade. Similarly, when it comes to posting of EUR cash
collateral, EONIA is the PAI rate and the discount rate. European Money Markets Institute (EMMI) has announced
that EONIA will be withdrawn at end of the 2021. CSAs referencing this rate should be updated before that date,
for example, by replacing with €STR.
For CSAs where non-cash collateral is used, e.g. government bonds, margin interest is not transferred between
counterparties, therefore there is no need for any renegotiation to change the discounting rate used to value
the trade. The discounting rate used to value the underlying derivative contracts of these CSAs is aligned to the
funding rate for this collateral in the secured funding market. As an example, if US Treasuries are the only eligible
collateral, this could currently mean that the discount rate used is EFFR for the CSA. This rate could change to SOFR
once the secured funding market adopts SOFR as the funding rate instead of EFFR.
CSA changes are beginning to accelerate post the switch from EONIA to €STR and from EFFR to SOFR by the CCPs
in July and October 2020 respectively. The switch in discounting rates is a significant milestone for the LIBOR
transition as it is expected that market participants will look to switch their discounting risk to match CCPs, thereby
establishing hedging and re-hedging requirements in transactions referencing these ARRs: a key driver for adoption
of ARRs as the market standard floating rate.
Why will these changes drive an increased Bilateral Negotiation of CSAs?
In addition to the negotiations mandated by the Margin Requirements for Non-Centrally Cleared Derivatives
regulations6 (with the first phase effective 1st September 2016 and final phase due 1st September 2021), CSA
renegotiations driven by LIBOR transition are expected to be a major exercise. Given the majority of OTC contracts
referencing LIBOR are cleared, there is an expectation that market participants may want to ensure that both
current regulatory mandated and non-mandated bilateral CSAs are in line with CCP discounting and PAI.
The industry has largely been through the transition from using LIBOR to overnight rates for discounting. The
expectation is that the transition from current overnight rates (EONIA, EFFR) to ARRs (€STR, SOFR) will not be as
5 https://www.theotcspace.com/content/price-alignment-interest-pai
6 https://www.bis.org/bcbs/publ/d475.htm
10SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
challenging as the transition from LIBOR to ARR for forecasting. Forecasting changes will be discussed in the next
section.
When will UBS be ready to open CSA negotiations?
UBS has already commenced a number of CSA negotiations after the CCP transition dates to switch existing CSAs
referencing EONIA to ESTR and EFFR to SOFR. Please contact your Sales representative if you wish to start this
process and you have not been contacted yet.
What is the impact on swaption contracts?
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.
Summary and Practical Considerations
Below are some of the practical considerations clients should take into account for this LIBOR transition
Summary Practical Considerations include
• Discounting rate and interest paid on cash collateral • Review eligible collateral terms in your CSAs
are usually aligned (specifically cash interest rate on margin)
• Assess the economic impact of switching your
interest rates
• The switch in discounting rates by CCPs is likely to • Be mindful that basis risk may exist between your
be a key driver for increased adoption of these new cleared and bilateral portfolios
ARRs across the industry • Consider which CSAs you may need to prioritize
renegotiation for in order to reduce this potential
basis risk
• Any changes to the margin annex for a derivative • A change to the cash margin rate in the agreement
contract should reference the new ARR to replace will result in a change in margin interest flows and
existing cash margin rate. potentially the discounting curve used for the
underlying derivative portfolio
• Consider there may be a value transfer with your
bilateral counterpart for this change that will need to
be agreed
If you have any further questions, in the first instance please contact your sales representative. Alternatively, please
get in touch via UBS-IB-LIBOR@ubs.com.
7 https://www.isda.org/a/W17TE/Swaptions_Settlement-and-Consequences-of-discounting-changes-memorandum.pdf
11SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
4. LIBOR Transition: Forecasting Risk
What is Forecasting Risk?
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 occurs when market participants switch out of LIBOR referenced contracts into ARR
referenced contracts as market liquidity allows, rather than waiting until LIBOR ceases to exist. This activity would
see ARR forecasting risk gradually replace LIBOR forecasting risk.
The ARR forecasting curve is generally lower than the LIBOR equivalent.
What are the Fallback Provisions?
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 LIBOR-
referencing 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.
Term Definition
Fallback Fallback language refers to the legal provisions in a contract that apply if the underlying
Language reference rate (e.g. LIBOR) in the product is not published (whether on a temporary or
permanent basis).
Fallback Rate The reference rate replacing LIBOR upon the Fallback Trigger Event. The updated ISDA
Definitions specify ARRs as compounded in arrear settings as replacement rates for derivative
contracts referencing LIBOR. However certain cash product contracts may contain no suitable
language, resulting in the contracts falling back to the last LIBOR setting or the lenders' costs of
funds.
Spread As noted LIBOR is different to the ARR applicable in each jurisdiction and as part of ISDA fallback
Adjustment methodology a fixed spread adjustment is applied to the ARR to account for differences in the
construction of LIBOR and the ARR.
Fallback Set of events relating to the original reference rate which may trigger the fallback to a new
Trigger Event Reference Rate.
Clients should consider the economic and financial impact of the fallback provisions in their own contracts.
12SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
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.
What are some examples of differing fallback methods?
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).
How will the LIBOR transition affect new contracts executed under the updated
ISDA Definitions?
The updated ISDA Definitions will become effective on 25 January 2021. All new derivative contracts executed after
this date under the 2006 ISDA Definitions will contain the new fallback provisions. These updated Definitions
include pre-defined ARR-based fallbacks for LIBOR and certain other IBORs and are triggered upon the occurrence
of a pre-cessation or cessation announcement.
How will the LIBOR transition affect the existing contracts?
ISDA published the 2020 IBOR Fallbacks Supplement and Protocol on 23 October 20209. The new fallbacks will
become 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 Supplement10 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.
Has UBS adhered to the 2020 IBOR Fallbacks Protocol?
UBS has adhered to the ISDA 2020 IBOR Fallbacks Protocol across all of its main trading entities.
What does this mean now that UBS has adhered to the IBOR 2020 Fallbacks
Protocol?
Where both bilateral parties in over-the-counter (OTC) derivatives adhere to the ISDA 2020 IBOR Fallbacks Protocol,
relevant trades will have certainty of replacement rates upon a fallback trigger event.
9 https://www.isda.org/2020/10/23/isda-launches-ibor-fallbacks-supplement-and-protocol/
10https://www.isda.org/book/isda-benchmarks-supplement/
13SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
IBOR fallbacks are triggered once LIBOR is deemed non-representative (also known as pre-cessation) or ceases to be
published. Relevant trades are those traded before 25 January 2021 and are included within the list of
documentation types within the ISDA 2020 IBOR Fallbacks Protocol.
What is expected to happen to cleared contracts?
CCPs have indicated they will look to apply the updated ISDA Definitions for all contracts (new contracts executed
under updated Definitions as well as existing contracts)11.
If CCP rulebooks are amended, will bilateral / manual amendments be required
to ETD agreements with UBS?
There is no requirement to repaper ETD Clearing Agreements as UBS mirrored relevant CCP rulebook
provisions in its ETD agreements. There may be some commercial changes around the benchmarks used to
calculate interest paid/received on margin balances but this resides outside of the ETD agreement and is part of the
commission schedule. These changes would be discussed and agreed with clients ahead of implementation.
How will the LIBOR transition affect products other than OTC derivatives?
Although the ISDA Protocol covers some non-derivative agreement types, products such as loans and bonds sit
outside of its scope. The industry is still working on approaches to improve the fallback language for such products.
How could hedge effectiveness across asset classes via linked transactions be
affected by the LIBOR transition?
Differences in fallback methodology across different product types have added more complexity to the transition
for linked transactions. For example, a swap hedging the LIBOR component of a bond or loan may continue to be
an effective hedge upon the triggering of differing fallback methodologies. Market participants may need to review
any linked or hedged transactions and evaluate contractual fallbacks in place.
What is the ISDA LIBOR to ARR adjustment?
ISDA has consulted with the industry to determine a market consensus on the methodology used to calculate
the adjustment spread to address the term and credit differences between LIBOR and the ARR and other factors
such as liquidity and fluctuations in supply and demand.
These consultations12 have established that market participants prefer to use the compounded setting in arrears
rate to address differences in tenor between IBORs and overnight ARRs, and the historical median spread over a
five-year lookback period approach.
Note that Bloomberg has begun to publish these LIBOR fallback rates as per ISDA's agreed methodology as of 21
July 2020. The real time data can be accessed via FBAK on Bloomberg Terminals, and is publicly available,
with a delay, on the Bloomberg website13.
Upon an announcement on permanent or pre-cessation, the spread adjustment under the ISDA Fallbacks for LIBOR
will be fixed.
What are the ARRC's recommended best practices?
ARRC published its best practices14 for completing transition from LIBOR to provide date-based guidance, including
when no new LIBOR activity should be conducted. Please see Appendix ARRC recommended best practices for
further information.
11
https://www.isda.org/a/md6ME/FINAL-Pre-cessation-issues-Consultation.pdf
12 https://www.isda.org/a/WhXTE/Adoption-of-Risk-Free-Rates-Major-Developments-in-2020.pdf
13 https://www.bloomberg.com/professional/solution/libor-transition/
14 https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-Best-Practices.pdf
14SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
What is Pre-Cessation?
Cessation and Pre-Cessation Definitions
Terms Definition
Cessation Event Event whereby a reference rate is discontinued or unavailable permanently, triggering
Fallback. A typical LIBOR cessation event would occur if there were no longer sufficient
panel banks contributing to calculation of LIBOR
Pre-Cessation Event An event which impacts the reference rate but does not prevent its publication. With
respect to LIBOR, such an event could be where the FCA deems LIBOR unrepresentative
per Benchmarks Regulation and prohibit its use in contracts.
ARRC15 recommended the industry to include Pre-Cessation as a Fallback Trigger event in the Fallback Provisions for
any new cash products referencing LIBOR.
The updated ISDA Definitions include both pre-cessation fallbacks (based on a 'non-representativeness'
determination) and permanent cessation fallbacks. This will apply to all new derivatives referencing LIBOR that
incorporate the amended 2006 ISDA Definitions traded after the effective date 25 January 2021. For Legacy trades
(i.e. those transacted prior to the effective date of the updated Definitions which is 25 January 2021) market
participants are expected to evaluate whether the updated Definitions which are appropriate and incorporate via
adherence to the ISDA 2020 Fallbacks Protocol.
What is 'Synthetic LIBOR'?
On 23 June 2020 HM Treasury16 announced that it intends to bring forward legislation to amend the Benchmarks
Regulation (BMR) to give the FCA new and enhanced powers. These could help manage and direct an orderly
wind-down of critical benchmarks such as LIBOR. The proposed changes will create a possible way of reducing
disruption by enabling continued publication of a LIBOR rate using different and more robust methodology and
inputs.
The legislation would allow the FCA to direct a change to the methodology, if doing so would better protect
consumers and the integrity of the market than cessation of the rate. By acting via the administrator, certain LIBOR
currency and tenor settings (including the screen rates) are expected to be preserved and remain in place under the
new methodology for an extended period.
We will refer to this continued publication of LIBOR under a different methodology as 'Synthetic LIBOR’. The FCA’s
Statement on 18 November 2020 provided a clearer indication of which LIBORs may be able to be continue
publication in the form of Synthetic LIBOR, albeit for specific use cases. CHF and EUR LIBOR are unlikely to meet
requirements under the new methodology, while GBP LIBOR is likely to continue; JPY and USD LIBOR are yet to be
determined. The FCA has also indicated that they envisage calculating GBP Synthetic LIBOR based on a forward
looking SONIA Term Rate plus a fixed adjustment spread under the same ISDA methodology.
What are the implications of 'Synthetic LIBOR' on Transition?
Regulators still expect the same focus and urgency from market participants to transition from LIBOR by primarily
actively switching from LIBOR contracts into ARR contracts or failing that, to insert robust and workable fallback.
These new and enhanced powers may allow the continued publication of LIBOR (including the screen rates) with a
more robust methodology and inputs. It is expected to be based on forward looking term ARRs plus a fixed
adjustment spread per ISDA methodology.
Synthetic LIBOR is also expected to be restricted by the FCA17 for use by UK supervised entities to some or all tough
legacy contracts. Tough Legacy contracts are contracts that have no or inappropriate/unviable alternatives and no
realistic ability to be renegotiated or amended. A policy of statement is expected from the FCA to define which
tough legacy contracts could use Synthetic LIBOR following its consultation in Q2 2021.
15 https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/FRN_Fallback_Language.pdf
16 https://www.fca.org.uk/markets/transition-libor/benchmarks-regulation-proposed-new-powers
17 https://www.fca.org.uk/news/statements/fca-statement-planned-amendments-benchmarks-regulation
15SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
What are the latest expected publication dates for LIBOR?
Subject to the outcomes of its consultations, ICE Benchmark Administration (IBA) announced in November 2020
that they will cease publication of GBP, CHF, EUR and JPY LIBOR (all tenors) and USD LIBOR (1-Week and 2-Month)
at the end of 2021. However, other USD LIBOR tenors will continue to be published by IBA until end-June 2023.
The implications of this is that some bifurcation of cessation timelines and transition approaches across LIBOR
currencies is now expected, including:
• USD LIBOR: the expected final publication of USD LIBOR Tenors (except 1W and 2M) will be 30 June 2023.
Firms are expected to cease entering into new contracts using USD LIBOR as soon as practical or at the latest by
31 December 2021. Existing contracts that have not been transitioned upon cessation may be impacted by
potential legislation underway in the US. To-date, the FCA has not indicated any plan for Synthetic USD LIBOR.
• GBP LIBOR: a pre-cessation announcement is likely in 2021 with the effective date on or shortly after 31
December 2021. A Statement from the FCA indicated that GBP LIBOR is likely to continue publication under an
amended methodology of a SONIA term rate + fixed spread (defined as Synthetic GBP LIBOR) with expected
restrictions upon its usage.
• CHF, EUR LIBOR: the expected final publication is 31 December 2021. Continued publication is unlikely.
• JPY LIBOR: the expected final publication is 31 December 2021. Continued publication under an amended
methodology is yet to be decided.
IBA will close the consultation for feedback by 25 January 2021. To-date, there has been no decision on whether
other currencies linked to USD LIBOR (e.g. SOR) would update their timelines to align with USD LIBOR.
A joint statement was issued by the Federal Reserve, Office of the Comptroller of the Currency (OCC) and the
Federal Deposit Insurance Corporation (FDIC) on 30 November, stating that firms should not enter into new
transactions referencing USD LIBOR after 31 December 2021. Additionally, in light of potential safety and
soundness concerns around new USD LIBOR contracts, they would examine firms' current practices.
Why is the Transition challenging for certain products?
Certain contracts which reference LIBOR (including bonds, structured products, securitized products, loans and a
subset of existing contracts) may have characteristics that impede smooth transition such as product mechanics for
material amendments, non-linearity, illiquidity or because they act as hedges to products with different fallback
methods.
Non-Protocol Covered agreements and confirmations may need to be reviewed to determine an approach.
Generally, this approach is likely to involve market participants being requested to sign documentation agreeing to
incorporate robust fallback language to allow the transition to the relevant replacement rate.
Why might these Forecasting Risk changes drive increased bilateral/ multilateral
negotiation?
Due to the increased complexity introduced by the differences between asset class fallbacks and product
amendment mechanics, the industry is expected to need to perform a significant review of contractual
documentation before agreeing to change terms on their existing trades. Amendments to existing trades will be a
challenging exercise if market participants have to amend a significant volume of trades across different products
on a bilateral or multilateral basis.
What are the main drivers that may determine the impact on Forecasting Risk?
The level of impact on value and Forecasting Risk will be driven by but not limited to the following:
• The specific legacy reference rate
• Whether term rates become available
• The specific fallback trigger provisions in existing contract(s)
• Fallback rate to include an adjustment required to reflect the credit and term differences agreed by
industry groups
• The maturity of the contract(s)
• The date when changes are expected to happen
• The type of product as there are potentially differing industry solutions
There is no industry consensus on how the change in the value of contracts between parties will be handled.
16SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
Summary and Practical Considerations
Clients should study existing contracts that reference LIBOR and consider future trading and risk management
requirements and seek professional advice (if applicable) on the economic, legal, and operational implications.
Clients may also consider their specific capital, accounting, and tax consequences of LIBOR transition.
Below are some of the practical considerations clients should take into consideration for this LIBOR transition.
Summary Practical Considerations include
• Increased complexity may be introduced by the • You should perform a review of contractual
differences between asset class fallbacks documentation before agreeing to change terms on
existing trades keeping in mind that current fallback
provisions may create, upon cessation, a fallback to a
rate inconsistent with the economics of the original
deal
• Acknowledge that in any new fallback provisions
that specify an ARR to replace LIBOR, there may be
an adjustment (to address the term and credit
differences)
• Updated ISDA Definitions and ISDA 2020 IBOR • New OTC derivative contracts executed under ISDA
Fallbacks Protocol published 23 October 2020 Definitions will incorporate robust fallbacks effective
from 25 January 2021. For legacy OTC derivative
trades, you should consider and determine whether
to adhere to the ISDA 2020 IBOR Fallbacks Protocol
to incorporate robust fallbacks
• Differences in fallback methodology across different • Identify all transactions which you believe to be
product types may impact hedge effectiveness across linked and evaluate contractual fallbacks in place in
transactions which you believe to be linked order to determine an approach to mitigate potential
differences in fallback methodology across these
transactions
• Evaluation of current contractual fallback provisions • You may be requested to sign documentation
may lead to increased bilateral discussion agreeing to the transition to the relevant
replacement rate or adopt the ISDA Benchmark
Supplement. However the latter is an alternative
path that does not provide certainty of economic
outcome
• Stay up to date with the industry announcements • Categorize your in-scope population of trades in
related to cessation or pre-cessation announcement relation to possible transition activities. Note any
dates as these will fix fallback rates spreads. Also be dependencies you require such as market readiness
aware of how Synthetic LIBOR methodology or internal system/operational development.
develops as some 'Tough Legacy' contracts may end
up referencing this rate
If you have any further questions, in the first instance please contact your sales representative. Alternatively,
please get in touch via UBS-IB-LIBOR@ubs.com.
1718
SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
5. Regulatory and Market Milestones
18SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx 6. Regulatory and Market Milestones Continued
SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
7. Appendix
ARRC Recommended Best Practices
IT/Operational
Target for No New Anticipated Fallback
Vendor
Hardwired Fallbacks USD LIBOR (maturing Rates to be selected
Product Incorporated by Readiness beyond 2021) by
Floating Rate 30th June 2020 30th June 2020 31st Dec 2020 6 months before the
first reset/fixing
Notes
scheduled after
LIBOR cessation
Business Loans 30th Sept 2020 30th Sept 2020 for 30th June 2021 6 months before the
Syndicated Loans first reset/fixing
scheduled after
31st October 2020 for
Bilateral Loans LIBOR cessation
Consumer Loans Mortgages: Mortgages: Mortgages: Specific consumer
regulations
30th June 2020 30th Sept 2020 30th Sept 2020
Student Loans: 30th
Sept 2020
Securitizations 30th June 2020 31st Dec 2020 CLOs: 30th Sept 2021 6 months before the
first reset/fixing
Other: 30th June 2021
scheduled after
LIBOR cessation
Derivatives 25 January 2021 Dealers to act to deliver 30th June 2021
a liquid
SOFR derivatives
markets to clients
Note: These dates may be updated following the IBA consultation announcement on its intention to cease publication of most
USD LIBOR tenors by Jun 2023
20SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
FINMA’s Recommendations and Transition Roadmap for 2021
FINMA recently issued guidance17 to clarify FINMA’s recommendations to affected supervised institutions and
market participants, to ensure that they use the time until the end of 2021 to prepare for a discontinuation of
LIBOR in CHF, EUR, GBP and JPY (in all tenors), and in USD (in the 1W and 2M tenors) across all product types.
Date Milestones
By 25 Signing of ISDA 2020 IBOR Fallbacks Protocol
January 2021
No new “tough legacy”: Across Readiness to grant loans based
By 31
all product types, there should be on ARR: If they are lenders, the
January 2021
no new transactions based on CHF affected supervised institutions
or EUR LIBOR that mature after should be in a position to grant
end-2021 and do not contain loans that are not based on CHF,
robust fallback clauses. Where EUR, GBP, JPY or USD LIBOR. This
possible, the same objective can be achieved by giving
should also be aimed at for new borrowers the possibility to choose
transactions based on GBP, JPY or another rate (fixed interest and/or
USD LIBOR. an ARR such as SARON).
Plans for the reduction of “tough legacy”: Based on a full evaluation of their inventory of
By 31 March
existing CHF and EUR LIBOR contracts, the affected supervised institutions should have determined
2021
which contracts and what volume are potentially “tough legacy” as they mature after 2021 and
do not contain robust fallback clauses. Institutions should have formulated detailed project plans
with steps to be taken and progress monitoring in order to reduce this volume of “tough legacy”
contracts to a minimum by end-2021.
System and process changes Mitigation of risks for
By 30 June New contracts in
implemented: The affected remaining “tough legacy”: By
2021 general based on ARR:
supervised institutions should have implementing the plans set out
In general, the affected
implemented the system and above for the reduction of “tough
supervised institutions
process changes necessary to legacy”, and by considering the
should only use ARR in
enable transition to ARR and the progress of negotiations already
new CHF, EUR, GBP, JPY
application of fallback rates. conducted with the counterparties
and USD contracts.
or other solutions that are already
in place, it should be clear
whether the objective of reducing
the volume of tough legacy
contracts in CHF and EUR LIBOR
and the discontinued GBP and JPY
LIBOR tenors, as well as the 1W
and 2M tenors of USD LIBOR, to a
minimum is achievable.
17 https://www.finma.ch/en/news/2020/12/20201204-am-libor/
21SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
Date Milestones
Full operational readiness: All All new contracts based on
By 31
relevant systems and processes ARR: All new transactions with
December
should already be able to function variable interest in CHF, EUR, GBP,
2021
without reliance on LIBOR JPY and USD should be based on
ARR.
31 December Intended discontinuation of LIBOR
2021
Please note that individual tenors of USD LIBOR may continue to be available until the end of June
2023
22SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
BoE RFR Working Group - Revised target milestones to manage transition away
from Sterling LIBOR linked products by end 2021
By End Of: Q4 2020 Q1 2021 Q2/Q3 2021
• Adhere to the ISDA • Cease initiation of new • Assess and actively
Derivatives
protocol before the Sterling LIBOR linked linear convert where viable (e.g.
effective date* derivatives expiring after auction / compression
2021 (except for risk mechanisms)
• Be operationally ready to management of existing
support the development positions)** • Cease trading of LIBOR
and market making of non- linked non-linear
linear and cross-currency derivatives, and cross-
SONIA derivatives currency derivatives with a
sterling leg, expiring after
• Sterling swaps liquidity 2021 (except for risk
providers to adopt new management of existing
interdealer quoting positions)
conventions based on
SONIA and move to use of
single period swaps rather
than forward rate
agreements on 27 October,
subject to prevailing market
conditions.
• Progress active conversion • Cease new issuance of • Complete active
Bonds and
(e.g. consent solicitation Sterling LIBOR-referencing conversion where viable
Securitisations
mechanisms) where viable products maturing after
to reduce legacy volume 2021
• Complete assessment of
allpost-2021 contracts to
identify those that can be
actively converted
• Accelerate active conversion
where viable (e.g. consent
solicitation mechanisms) to
reduce legacy volume
23SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
By End Of: Q4 2020 Q1 2021 Q2/Q3 2021
• Progress active conversion • Cease new issuance of • Complete active
Loans
(e.g. at renewal, proactive Sterling LIBOR-referencing conversion where viable
negotiation, or using pre- products maturing after
agreed terms) where viable 2021 • Where active conversion is
to reduce legacy volume not possible, ensure
• Complete assessment of robust fallbacks are
allpost-2021 contracts to adopted
identify those that can be
actively converted
• Accelerate active conversion
(e.g. at renewal, proactive
negotiation, or using pre-
agreed terms) where viable
to reduce legacy volume
Note:
*Subject to individual firms’ usual governance procedures and negotiations with counterparties as necessary. Where the protocol is not used,
other appropriate arrangements will need to be considered to mitigate risks.
** The RFRWG recognises that dealers and other market makers executing such trades for their clients may accumulate LIBOR risk as a result
and that they cannot necessarily assess, or reasonably be expected to seek to discover, the intent of their clients when approached to initiate a
LIBOR derivative trade. Discussions are ongoing on a conventions switch from LIBOR to SONIA in the derivative markets, and this includes non-
linear derivatives, cross currency swaps and futures. It is acknowledged that non-linear and cross-currency RFR markets currently remain nascent,
and that there will be further developments on the approach for transition of legacy non-linear derivatives during 2020.
24SH-Presentations Client Guide (UBS Format) UNAPPROVED v6.0.10.docx
Other IBORs Benchmark Rates
The other IBOR benchmark rates are detailed in the below table.
Jurisdiction Reference Rate Administrator Commentary
Euro Area EURIBOR EMMI The most widely used benchmark of the other IBORs; the
European Commission has expressed confidence in EURIBOR
for the medium term. A new hybrid methodology is in the
process of being implemented.
The ECB RFR WG proposed roadmap18 (published in late
2019) suggests that 2020 work focus are on:
i) EONIA transition to ESTR, particularly on building liquidity
for ESTR and the CCP discounting switch that occurred on
Monday 27 July, and
ii) Development of ESTR-based fallbacks for EURIBOR,
however the final recommendation has been deferred to Q1
2021 due to COVID 19 impact per the May ECB RFR WG
minute.
A list of key milestones and publications can be found from
the ECB RFR WG website19
On 23 November 2020, the ECB Working Group on Euro Risk-
Free Rates published two public consultations on fallback
rates to EURIBOR, calling for views on:
1. Fallback rates based on €STR and spread adjustment
methodologies in order to produce the most suitable EURIBOR
fallback measures per asset class
2. Potential events that could trigger such fallback
measures.20
Japan TIBOR JBA
In August 2020 the BoJ Cross-Industry Committee on
Japanese Yen published its latest consultation21 on JPY
interest rate benchmarks, recommending fallback
replacement rates and spread adjustments for legacy cash
products referencing JPY LIBOR. The consultation paper
included a draft transition roadmap, setting out key transition
targets:
• start negotiating amongst contracting parties from 3Q
2020
• developing loans and bonds systems and operations
on compounded ARRs in arrears by end 1Q 2021
• publication of daily prototype rate from 4Q2020 and
forward looking term rate by mid-2021
• ceasing new LIBOR loans and bonds by end 2Q 2021,
and significant reduction of LIBOR stock by end 3Q 2021.
18
https://www.ecb.europa.eu/paym/initiatives/interest_rate_benchmarks/WG_euro_risk-
free_rates/shared/pdf/20191204/2019_12_04_WG_on_euro_RFR_meeting_Item_2_Planning_for_the_WG_H1_2020.pdf
19 https://www.ecb.europa.eu/paym/initiatives/interest_rate_benchmarks/WG_euro_risk-free_rates/html/milestones.en.html
20 https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr201123~1d59dcbe27.en.html
21 https://www.boj.or.jp/en/paym/market/jpy_cmte/index.htm/
25You can also read
