IBOR reforms

Overview

Interest rate benchmarks including, among others, the London Interbank Offered Rate (LIBOR), the Euro Interbank Offered Rate (EURIBOR), the Euro Overnight Index Average (EONIA) and certain other Interbank Offered Rates (IBORs) are being reformed.

The UK Financial Conduct Authority (FCA) has stated that after 2021 it will no longer compel banks to submit rates used for the calculation of LIBOR. This means that LIBOR is expected to be discontinued post December 2021. Regulators globally have emphasised that it is now time for market participants to start transitioning from the use of IBORs to alternative rates.

Regulatory authorities and public and private sector working groups in several jurisdictions, including the International Swaps and Derivatives Association (ISDA), the Sterling Risk-Free Rates Working Group, the Working Group on Euro Risk-Free Rates, and the Alternative Reference Rates Committee (ARRC), have been discussing alternative benchmark rates to replace the IBORs. These working groups are also considering how to support a transition to alternative rates and the development of new products referencing them.

These reforms are expected to cause some interest rate benchmarks to either perform differently to the way that they do currently or to disappear. This may impact the HSBC products and services you currently use and those we may provide in the future.

The content of this page reflects HSBC’s current understanding of the expected changes as at 28 September 2020. There still remains a high degree of uncertainty around LIBOR transition. This overview is not complete or exhaustive and does not constitute any form of advice or recommendation. Clients should contact their professional advisors on the possible implications of the changes such as financial, legal, accountancy or tax consequences.

Background

A wide range of financial products such as derivatives, bonds, loans, structured products and mortgages, use benchmark rates to determine interest rates and payment obligations. Benchmark rates are also used to value certain financial products and as a performance tracker for funds, among other purposes.

LIBOR, probably the most widely used benchmark, is used in financial products denominated in a number of currencies and is published in GBP (British Pound), USD (US Dollar), EUR (Euro), JPY (Japanese Yen) and CHF (Swiss Franc).

Certain currencies also use specific benchmarks such as EURIBOR and EONIA for EUR, the Tokyo Interbank Offered Rate (TIBOR) for JPY, the Hong Kong Interbank Offered Rate (HIBOR) for Hong Kong Dollar and the Singapore Interbank Offered Rate (SIBOR) for Singapore Dollar.

Financial regulatory authorities have expressed their concern that the interbank lending market, which IBORs are intended to reflect, is no longer sufficiently active or liquid. In particular, the regulatory concern is that the low levels of underlying activity make it “fragile and more susceptible to liquidity and amplification effects in financial markets”.

This concern has resulted in recommendations made by the Financial Stability Board (FSB) in 2014 to reform major interest rate benchmarks and use near risk-free rates (RFRs) that are based on more active and liquid overnight lending markets, instead of IBORs where appropriate.

RFRs are typically backward-looking overnight rates based on actual transactions and reflect the average of the interest rates that certain financial institutions pay to borrow overnight either on an unsecured basis from wholesale market participants for unsecured RFRs, such as the Sterling Overnight Index Average (SONIA) or the average rate paid on secured overnight repurchase or “repo” transactions for secured RFRs, such as the Secured Overnight Financing Rate (SOFR).

RFRs do not include or imply any credit or term premium of the type seen in LIBOR or EURIBOR. However, RFRs are not truly free of risk. RFRs can rise or fall as a result of changing economic conditions and central bank policy decisions.

What are the replacement benchmarks and which benchmarks are changing?

RFR working groups in a number of jurisdictions have identified replacement benchmarks and continue to develop strategies for transition. Select examples of benchmarks which are either being replaced or benchmarks where changes either have or are expected to be made to their methodology (notably the way in which they are determined) are set out in the table below.

Currency

Current rate

Alternate Rate

Anticipated Approach

Australian Dollar (AUD)

Bank Bill Swap Rate (BBSW)

BBSW’s new methodology became effective on 21 May 2018. The Cash Rate, also referred to as AONIA, is a pre-existing rate that will become the RFR for AUD.

Australia is adopting a multi-rate and maintains the BBSW as the credit-based benchmark for the Australian Dollar.

Canadian Dollar (CAD)

Canadian Dollar Offered Rate (CDOR)

An updated version of the Canadian Overnight Repo Rate Average (CORRA), a pre-existing rate, has been identified by the Bank of Canada's Canadian Alternative Reference Rate Working Group as the preferred RFR for Canada.

Canada is adopting a multi-rate approach with both CDOR and CORRA co-existing as interest rate benchmarks.

Swiss Franc (CHF)

CHF LIBOR

Swiss Average Rate Overnight (SARON).

Transition to SARON, which is a pre-existing rate that was recommended as the alternative to CHF LIBOR in October 2017. LIBOR is expected to cease after end-2021.

Euro (EUR)

Euro Overnight Index Average (EONIA)

Euro Short-Term Rate (€STR).

Transition to €STR. EONIA continues to exist under a new methodology since 2 October 2019 to allow a smooth transition to €STR. EONIA is expected to be discontinued on 3 January 2022.

Euro (EUR)

Euro Interbank Offered Rate (EURIBOR) and EUR LIBOR

€STR.

Multiple rate approach. EURIBOR: reforms to EURIBOR’s methodology were completed in Q4 2019. EURIBOR is expected to continue alongside €STR beyond 2021 and there is no current indication it will cease in the near future. However, the ECB recommends using €STR as the primary basis for a fallback rate (where appropriate).

EUR LIBOR: LIBOR is expected to cease after end-2021. Market participants are expected to transition to €STR.

Sterling (GBP)

GBP LIBOR

Sterling Overnight Index Average (SONIA).

Transition to SONIA. SONIA has been subject to a number of reforms and these were implemented from 23 April 2018. LIBOR is expected to cease after end-2021.

Hong Kong Dollar (HKD)

Hong Kong Interbank Offered Rate (HIBOR)

Hong Kong Overnight Index Average (HONIA), which was a pre-existing rate.

HIBOR has been subject to a number of reforms.

The Working Group on Alternative Reference Rates and Hong Kong Treasury Markets Association identified HONIA as the alternative RFR but announced there is no plan to discontinue HIBOR. Hong Kong will therefore adopt a multi-rate approach, whereby HIBOR and HONIA will co-exist.

Japanese Yen (JPY)

JPY LIBOR, Tokyo Interbank Offered Rate (TIBOR) and Euroyen TIBOR

Tokyo Overnight Average Rate (TONAR) is the alternative RFR for Japanese Yen.

Reforms to TIBOR.

Japan is implementing a multi-rate approach with TONAR being promoted by the JPY Committee where appropriate, while recognising that the JBATA implemented TIBOR reforms should ensure that TIBOR can continue to be used. Considering the developments in international financial benchmark initiatives, JBATA has started to discuss the issue of integrating JPY TIBOR and Euroyen TIBOR, with the possibility of Euroyen TIBOR being discontinued.

Singapore Dollar (SGD)

Singapore Interbank Offered Rate (SIBOR)

Anticipated transition to the Singapore Overnight Rate Average (SORA), a pre-existing overnight rate.

SIBOR is expected to be discontinued.

Recommended transition from SIBOR to SORA as part of a SORA-centred approach.

On 29 July 2020, the Association of Banks in Singapore (ABS), Singapore Foreign Exchange Market Committee (SFEMC) and the Steering Committee for SOR Transition to SORA (SC-STS) issued a joint industry report recommending the discontinuation of SIBOR and a shift to the use of SORA as the main interest rate benchmark for SGD financial markets.

Singapore Dollar (SGD)

Swap Offer Rate (SOR)

SOR is a pre-existing rate largely used in the derivatives market. Since USD LIBOR is an input for the calculation of SOR, the outlook for USD LIBOR beyond end-2021 has implications for the long term viability of SOR. SOR is also expected to be replaced by the SORA.

Transition to SORA. Various recent and ongoing work relating to the SOR to SORA transition. Important recent publications include the SC-STS transition roadmap from SOR to SORA and key priorities for 2020 (April 2020) and the SC-STS statement (June 2020).

US Dollar (USD)

USD LIBOR

Secured Overnight Financing Rate (SOFR).

Transition to SOFR, which has been published since April 2018. LIBOR is expected to cease after end-2021.

 

The table above is not exhaustive and is provided for general information purposes only. There may be other benchmarks which may be either discontinued or where changes have or will be made to their methodology.

The differences between IBORs and RFRs

LIBOR and most other IBORs are intended to measure unsecured interbank lending rates and therefore include or imply a credit spread.

The proposed RFRs are based on short-term wholesale transactions for unsecured RFRs (i.e. SONIA, TONA and €STR) and repurchase or "repo" transactions for secured RFRs (i.e. SOFR and SARON). As a result, RFRs do not require such a credit spread due to their overnight and near risk free nature. RFRs are, therefore, in most cases expected to be lower than their IBOR equivalents.

IBORs are "term rates", which means they are published for different periods of time such as 3 months or 6 months and are "forward looking", which means they are published at the beginning of the borrowing period. Due to IBORs “forward looking” nature it incorporates a term premium to compensate for the risk of default over the term for which it is calculated.

Most RFRs are "backward-looking" overnight rates based on actual historic transactions. They are published at the end of the overnight borrowing period. RFRs therefore do not incorporate any term premium which is imbedded in the IBOR calculation due to lending to another bank on a longer-term basis.

It is important to note that RFRs are not free of risk, hence they are considered “near risk-free”. RFRs can rise or fall as a result of changing economic conditions and central bank policy decisions.

To transition existing contracts and agreements that reference IBORs to the alternative benchmark rates, adjustments for credit and term differences may need to be incorporated and applied to the alternate rate. Industry working groups are reviewing methodologies for calculating these so-called “spread adjustments” and are considering whether robust forward-looking term versions of the RFRs can be developed.

When will the changes take effect?

UK LIBOR Transition Recommendations

As the regulator overseeing the administration of LIBOR, the UK’s Financial Conduct Authority (FCA) has reiterated its message that it will not require banks to submit to LIBOR after 2021. The FCA and the Bank of England have reconfirmed that firms cannot rely on LIBOR being published after the end of 2021, and that there will be no extension to this date notwithstanding the impacts of COVID-19.

In the ‘Further statement from the RFR Working Group on the impact of Coronavirus on the timeline for firms’ transition plans’, the Working Group on Sterling Risk-Free Reference Rates (Sterling RFR WG) working with the FCA and Bank of England recommended that:

  • Lenders should make non-LIBOR linked products available to their clients by the end of Q3 2020
  • Lenders should include clear contractual arrangements in all new and refinanced LIBOR-referencing loan products after Q3 2020, to facilitate conversion from LIBOR to an alternative rate before the end of 2021 through pre-agreed conversion terms or an agreed process for renegotiation
  • No LIBOR-referencing loan products which expire after the end of 2021 should be sold after the end of Q1 2021

US LIBOR Transition Recommendations

The Alternative Reference Rates Committee (ARRC) convened by the US Federal Reserve has published its Recommended Best Practices for Completing the Transition from LIBOR. They recommend that market participants act on the assumption that LIBOR will end as of December 31, 2021, and made the following recommendations for loans, with maturities after December 31, 2021, including renewal or refinancing arrangements:

  • All new business loans should include ARRC-recommended (or substantially similar) hardwired fallback language by September 30, 2020
  • Technology and operations vendors should support SOFR by September 30, 2020
  • USD LIBOR business loans maturing after 2021 should not be sold after June 30, 2021

HSBC’s Approach

In order to follow the recommendations of the Sterling RFR WG and ARRC, we will make non-LIBOR linked loans referencing USD LIBOR and Sterling LIBOR available to clients in line with the recommendations above.

From the end of Q3 2020:

  • we will be offering RFR based loans (subject to availability); or
  • we will include in LIBOR referencing loan documentation:
    • a “switch mechanism”, which means there will be an in-built switch from LIBOR to an RFR or other alternative rate upon a specified trigger and the loan documentation will include the mechanics and provisions for the use of that alternative rate; or
    • an agreed process for renegotiation, provided that the conversion terms take effect before the end of 2021; or
    • as appropriate in the case of certain USD loans, the ARRC’s hardwired fallback language.

Details of these changes will be discussed with you (and other lenders in the case of syndicated loan agreements) when we agree terms for, and negotiate, new loan documentation. They may vary from product to product, across regions and currencies and in line with industry developments. It is important to note that the changes will not simply be drafting changes, and we expect that a substantial degree of discussion on key commercial terms and technical points associated with the calculation and use of the alternative rate, particularly the new RFRs, will be required.

Further information on hedging products

It is important that you assess how LIBOR is used in all your financial products and services with HSBC and/or any other party. In relation to loan products, for example, the anticipated changes may have an impact on the effectiveness of any derivative transactions that are used to hedge the cashflows of such loans. You should consult with your professional advisers on these changes as they can give rise to potential mismatches between loans and derivatives, and they may also affect any hedge accounting treatment applicable to those products.

The International Swaps and Derivatives Association (ISDA) is currently expected to publish the ISDA 2020 IBOR Fallbacks Protocol in October 2020. This will enable parties to include new triggers and fallbacks dealing with the permanent or indefinite cessation and non-representativeness of LIBOR (ISDA Triggers and Fallbacks) in existing derivative contracts.

This final trigger would arise if, prior to a permanent or indefinite cessation of LIBOR, LIBOR were deemed by the FCA to be “no longer capable of being representative” or “non-representative” of underlying financial reality. This is sometimes referred to a pre-cessation trigger.

If you do intend to adhere to the IBOR Fallbacks Protocol, we encourage you to consider that, for derivative transactions that were entered into to hedge specific assets or liabilities, such as loans, the ISDA Triggers and Fallbacks may differ from loan triggers and fallbacks. This could result in the derivative no longer being an effective hedge for the underlying loan without a subsequent amendment to the derivative transaction.

The fallbacks in the IBOR Fallbacks Protocol will apply if LIBOR ceases to be provided permanently or indefinitely or if it is found to be non-representative. If an underlying loan is actively transitioned to an RFR, a mismatch could be created between the loan and the hedging derivative and so you may want to consider transitioning the loan and the hedging derivative at the same time.

As adherence to the IBOR Fallbacks Protocol has the effect of an amendment, if there are any consents required to amend any of your derivative transactions, you will need to have obtained these consents prior to your adherence.

HSBC clients should seek guidance from their professional advisors on the possible implications of the changes outlined in this article on their business including financial, legal, accounting and tax impacts. HSBC does not, through this page, provide any advice or recommendation or product offering, nor does it assume any responsibility to provide advice.

What could these reforms mean for HSBC clients?

These changes may impact the HSBC products and services you currently use and those we provide in the future. The extent of the impact will depend on a range of factors including the following:

  • which IBOR is referenced;
  • the nature of the "fallback" provisions, where the product includes such provisions (for example, the ISDA Benchmarks Supplement may be incorporated in your derivatives transactions);
  • the adjustment for credit and term differences (i.e. between the IBOR and the alternative near risk-free rate) defined by industry working groups;
  • the term of the product or contract;
  • the date when the changes will take effect; and
  • the nature of the product.

The reforms could have a number of impacts on clients. These impacts include possible changes to contractual documentation, adaption of operational processes/IT systems, changes to the value of products or the possibility of products no longer serving the purpose for which they were intended. Depending on the factors listed above, by way of example, the discontinuation of an IBOR referenced in a loan facility and its replacement by an agreed alternative benchmark may result in changes to the amount payable under the facility. Any changes in the amount payable will be clearly communicated to you.

The impact of the changes may also vary depending on whether the relevant benchmark is being discontinued or if it is being reformed. For example, in the case of any transaction referencing EURIBOR, the European Money Markets Institute (the administrator of EURIBOR) is changing the way in which it determines EURIBOR. This change could result in EURIBOR being higher or lower than would be the case if it were to be determined using the previous methodology.

We are actively monitoring developments and participating in a number of industry and regulatory working groups. HSBC will continue to provide more information on the changes, notably when there is more certainty on which new benchmarks are being adopted, their methodology, their term structure and the transition process agreed at industry level.

The changes may impact products and services in a number of ways and the information provided on this page cannot be, and is not, exhaustive. You should contact your professional advisors on the possible impact of the IBOR reforms on the financial products and services you use or may use in the future.

For more information

We will periodically update this page and provide communications relating to the changes. In the meantime, if you require any further information, please contact your usual Relationship Manager. HSBC may also provide you with product or service specific information which you should consider carefully. The Frequently Asked Questions below attempt to clarify some of the key IBOR reform themes.

 

If you would like more general information on interest rate reform and IBOR transition, the Financial Conduct Authority (FCA), the Bank of England, the U.S. Commodity Futures and Trading Commission (CFTC), the Federal Reserve Bank of New York (FRBNY), the U.S. Alternative Reference Rates Committee (ARRC), the European Central Bank (ECB), the Financial Stability Board (FSB), the International Organization of Securities Commissions (IOSCO) and some of the working groups and industry bodies that are considering these issues have published information which can be found on their websites.

Frequently Asked Questions

 

 

Last updated: 30 September 2020