Interest Rate Benchmark reform
Several interest rate benchmarks have been reformed, or are expected to be either phased out or reformed in the near future, all with the goal of producing more robust and reliable rates. If any of your products refer to such interest rate benchmarks (e.g. EURIBOR, EONIA, LIBOR), the below information may be relevant for you.
What are interest rate benchmarks?
Interest rate benchmarks are used worldwide to determine the interest amounts payable under financial products (such as loans, mortgage loans, derivatives, bonds) and for the valuation of those financial products.
Examples of commonly used interest rate benchmarks are the Euro Interbank Offered Rate (EURIBOR), the Euro Overnight Index Average (EONIA) and the London Interbank Offered Rate (LIBOR).
Why are interest rate benchmarks being reformed?
Interest rate benchmarks must be robust and reliable. The interest rate benchmarks that are subject to reform are based on the rates used by banks when lending money to each other in the interbank market. Because the interbank lending has decreased substantially since the 2008 financial crisis, regulatory authorities are concerned that the existing rates may no longer be representative or reliable. To reform the publication and use of interest rate benchmarks, the European Parliament adopted the European Benchmarks Regulation, which came into effect on 1 January 2018. As a consequence of this regulation and other regulatory initiatives, alternative rates have been developed. These alternative rates are more based on actual transactions and are therefore perceived to be more robust and reliable.
What is going to change?
EURIBOR was successfully reformed in 2019 and is currently compliant with the European Benchmarks Regulation. That means that, according to the European Money Markets Institute (EMMI), the benchmark can continue to be used for new and legacy contracts after 1 January 2022. Nevertheless, the long-term sustainability of EURIBOR depends on factors such as the continued willingness of the panel of contributing banks to support it, and whether or not there is sufficient activity in its underlying market.
On 11 May 2021, the Working Group on Euro Risk-Free Rates published its recommendations addressing events that would trigger fallbacks in EURIBOR-related contracts, as well as €STR-based EURIBOR fallback rates. While there is currently no plan to discontinue EURIBOR, the development of more robust fallback language addresses the risk of a potential permanent discontinuation and is in line the EU Benchmarks Regulation.
EONIA will cease to exist as of early 2022 and the EURO Short-term Rate (€STR) is it’s recommended replacement rate. €STR became available on 2 October 2019 and is calculated by the European Central Bank (ECB) based on transactions that banks report to the ECB on a daily basis.
In 2017 the Financial Conduct Authority (FCA) announced that it will not persuade or compel banks to submit data on which LIBOR is calculated after the end of 2021. On 5 March 2021 the FCA announced and confirmed that all LIBOR settings will either cease to be provided by any administrator or no longer be representative:
- immediately after 31 December 2021, in case of all sterling, euro, Swiss franc and Japanese yen settings, and the 1-week and 2-month US dollar settings; and
- immediately after 30 June 2023, in case of the remaining US dollar settings.
Various market-led working groups have recommended replacement rates based on Risk Free Rates as alternatives to LIBOR. Below an overview of these recommended alternatives per jurisdiction.
Alternative Reference Rate
|Euro area||EURIBOR, EONIA||Working Group on Risk Free Reference Rates for the Euro Area||Euro short-term rate (€STR)||Unsecured rate to reflect the wholesale euro unsecured overnight borrowing transactions with financial counterparties||European Central Bank|
|United States of America||USD LIBOR||Alternative Reference Rates Committee||Secured Overnight Financing Rate (SOFR)||Secured rate based on transactions in the US Treasury repo market||Federal Reserve Bank of New York|
|United Kingdom||GBP LIBOR||Working Group on Sterling Risk Free Reference Rates||Sterling Overnight Index Average (SONIA)||Unsecured overnight rate based on the rate at which interest is paid on sterling short-term wholesale funds where credit, liquidity and other risks are minimal||Bank of England|
|Switzerland||CHF LIBOR||The National Working Group on CHF Reference Rates||Swiss Average Rate Overnight (SARON)||Secured rate based on data from the Swiss repo market||SIX Exchange|
|Japan||JPY LIBOR||Study Group on Risk Free Reference Rates||Tokyo Overnight Average Rate (TONAR)||Unsecured rate based on uncollateralized overnight call rate market transactions||Bank of Japan|
What does this mean for you?
As interest rate benchmarks are being reformed or replaced by alternative reference rates, this may impact products and services which are currently provided to you. As a consequence, contract amendments may be required. NIBC is closely monitoring the developments and we will duly inform you when this applies to you.
We encourage you to review your outstanding products and associated documentation to assess the potential implications on your business and financing arrangements. Amendments to legal documentation and the updates of operational procedures are just a few examples of key areas you could consider and / or seek further professional guidance on.
For more information on this topic, please refer to the websites below.
- Dutch Banking Association (NVB)
- Working group on euro risk-free rates
- Working Group on Sterling Risk Free Reference Rates
- Alternative Reference Rate Committee
- International Swaps and Derivatives Association (ISDA)
- Loan Market Association (LMA)
- UK Financial Conduct Authority (FCA)
- Joint public statement on the forthcoming cessation of all LIBOR settings