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Swap Rates – LIBOR’s discontinuance and why you should pay attention – Have You Checked Your Documents?

The London Inter-bank Offered Rate, better known as LIBOR, once the gold standard for benchmarking interest rates across the globe, will officially cease quoting after end-2021. It was once dubbed the ‘world’s most important number’ due to its widespread referencing within contracts for elements such as risk, valuation, performance modelling and commercial contract.

In recent years, the LIBOR has attracted infamy not for its contractual prevalence but for widespread scandal arising from its manipulation. In 2012, an international investigation revealed a widespread plot by multiple banks including Barclays, DeutscheBank and Royal Bank of Scotland – to manipulate the daily LIBOR rate for profit. This was able to occur due to the method of calculating LIBOR whereby a panel of global banks submit an estimate of their borrowing costs to the Thomson Reuters data collection service at 1000 GMT. Thomson Reuters would remove the highest and lowest 25 percent of submissions and then average the remaining rates to determine LIBOR. In this financial scandal, banks were, from as early as 2003 colluding with each other regarding submissions. Since the scandal emerged transgressors have paid more than USD 9 billion in fines to regulatory bodies around the world.

Since the scandal first emerged, the integrity of LIBOR has been thrown into question and resulted in its fatal demise. While the official end date for LIBOR is the end of 2021, the relevance of LIBOR is likely to cease more promptly. This is due to LIBOR’s reliance on bank panellists submitting quotes to determine the rate – once the critical mass has evaporated so too will the benchmark.

What happens if LIBOR is still referenced in a derivative contract after it ceases to be quoted?

The consequences of referencing LIBOR in a derivative contract after it continues to be quoted is factually dependant and will turn on the construction of the relevant contract. Many derivative contracts contain a ‘benchmark fallback’ – these are safety nets to replace a disappearing benchmark with a substitute. These solutions, however, are generally not designed to be permanent. The International Swaps and Derivatives Association (ISDA), the pre-eminent derivatives trade association, has been working on a more permanent and flexible transition. ISDA has included a supplement to its 2006 Definition.  Under the terms of the supplement, new derivative transactions entered into on or after 25 January 2021 that incorporate the 2006 ISDA Definitions will include Risk-Free Rate benchmarks. The benchmarks are geolocation specific with SONIA the appropriate rate for the UK; SOFR – the US; €STR for the EU; TONA in Japan and AONIA in Australia.

Time to Review your Documentation

For CFD providers, LIBOR is most commonly referenced in swap rates. All CFD providers regardless of their jurisdiction should review their client agreement and other disclosure documents such as a Product Disclosure Statement in Australia. If the LIBOR is referenced, this will need to be replaced with a relevant benchmark.

CFD Providers should also review their contracts with hedging counterparties to see if LIBOR is referenced and what risk free rate fallback is being used.

If you would like to discuss this in more detail or for further assistance, please contact us.

A version of this article appeared on Finance Magnates and can be viewed here.

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