Beyond LIBOR – Implementing Benchmark

Reform
Tariq Zafar Rasheed, Partner
Presentation Overview

• Introduction
• What are IBORs?
• Why are IBORs being reformed?
• Alternative nearly risk free rates
• Transitioning from IBORs to RFRs
• Example financing structures
• Implementing an effective IBOR transition programme

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 – Introduction –
– What are IBORs? –
– Why are IBORs being reformed? –
– Alternative nearly risk free rates –
– Transitioning from IBORs to RFRs –
– Example financing structures –
– Implementing an effective IBOR transition –

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Introduction

• Following the 2012 Wheatley Report and the 2013 FSB Review, LIBOR and other
interbank offered rates (IBORs) have come under extreme scrutiny
• Global regulators have shown a strong preference for IBORs to be reformed (IBORs+)
• Public-/private-sector working groups have identified other nearly risk free rates (RFRs) to be used
as alternatives to IBORs
• Great likelihood that IBORs will cease to exist altogether. Reasons include the following:-
• lack of liquidity in interbank lending markets
• reluctance of panel banks to submit quotes due to litigation risk
• FCA’s declaration that it will not compel or persuade panel banks to make LIBOR submissions
after end of 2021
• the EU Benchmarks Regulation, which makes certain rates (e.g. EONIA) non-compliant

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 – Introduction –
– What are IBORs? –
– Why are IBORs being reformed? –
– Alternative nearly risk free rates –
– Transitioning from IBORs to RFRs –
– Example financing structures –
– Implementing an effective IBOR transition –

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What are IBORs?

• Interbank offered rate (IBOR)

• Average rate at which certain banks could borrow in the interbank market and range in tenors
from overnight to 12 months

• LIBOR Submission Question:- “At what rate could you borrow funds, were you to do so by asking
for and then accepting interbank offers in a reasonable market size just prior to 11 am?”

• Includes a spread reflecting the credit risk involved in lending money to banks

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What are IBORs? (contd.)

1 LIBOR (London interbank offered 2 EURIBOR (euro interbank offered

rate). The IBOR for the London rate). The rate offered in the euro
interbank market. interbank market.

A benchmark rate for 5 currencies (i.e.

GBP, CFH, EUR, JPY, USD) with 7 tenors
(i.e. overnight/spot next, 1-week, 1-
month, 2-month 3-month, 6-month, 12-
month). Number of currencies and tenors
was significantly reduced following 2012
Wheatley Review.
Administrator. ICE Benchmark
Administration (IBA). IBA maintains a
reference panel between 11 and 16
contributor banks.
NB. LIBOR is designated as a critical
benchmark under the EU Benchmarks
Regulation.
1 2 A benchmark rate in EUR with 6 tenors
(i.e. 1-week, 2-week, 3-month, 6-month,
LIBOR EURIBOR 9-month, 12-month).
IBORs
Administrator. European Money Markets
Institute (EMMI). EMMI maintains a
3 reference panel of 20 contributor banks.
NB. EURIBOR is designated as a critical
TIBOR benchmark under the EU Benchmarks
Regulation.

3 TIBOR (Tokyo interbank offered rate). The rate offered in the Japan interbank market.

There are two TIBOR rates: Japanese yen TIBOR rates reflect prevailing rates on the unsecured call
market, and the EUROYEN TIBOR rates are based on the Japan offshore market. Calculated for 6
tenors (i.e. 1-week, 1-month, 2-month, 3-month, 6-month, 12-month)

Administrator. JBA TIBOR Administration (JBATA)

NB. TIBOR’s administration is subject to the Financial Instruments and Exchange Act, which
includes rules pertaining to calculation, publication and administration of the benchmark rate.

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What are IBORs? (contd.)

Estimated at more than USD370tn across derivatives, bonds, loans and other
instruments

IBOR exposure is 4 times larger than global GDP

• USD LIBOR and EURIBOR. USD LIBOR and EURIBOR each represents more than
USD150tn on a gross notional volume outstanding basis. Together, they represent
approx. 80% of total IBOR market exposure (>USD370tn)
Sheer scale IBOR • OTC derivatives and ETDs. OTC derivatives and ETDs represent more than
exposure cannot be USD300tn (80%) of products referencing IBORs
over-estimated • Syndicated loans. 97% of syndicated loans in US market, with outstanding volume
of approx. USD3.4tn, reference USD LIBOR. 90% of syndicated loans in the euro
market, with outstanding volume of approx. USD535bn, reference EURIBOR
• FRNs. 84% of FRNs in the US market, with outstanding volume of approx. USD1.5tn,
reference USD LIBOR. 70% of FRNs in the euro market, with outstanding volume of
approx. USD2.6tn, reference EURIBOR
• Business loans. 30%-50% of business loans in the US, with outstanding volume of
approx. USD2.9tn, reference USD LIBOR. 60% of business loans in the euro market,
with outstanding volume of approx. USD5.8tn, reference EURIBOR
• Tenor. 3-month tenor by volume is the most widely referenced rate in all currencies
(followed by 6-month tenor)

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 – Introduction –
– What are IBORs? –
– Why are IBORs being reformed? –
– Alternative nearly risk free rates –
– Transitioning from IBORs to RFRs –
– Example financing structures –
– Implementing an effective IBOR transition –

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Why are IBORs being reformed?

Following the 2007-2008 Financial Crisis, there has been a severe decline in the
interbank unsecured funding markets

Panel banks are being obliged to submit quotes when there is limited activity backing
these submissions. This means submitted quotes are perceived to be based on
“expert judgement” rather than underlying market activity
Severe decline in
liquidity in
interbank According to FCA, in an extreme example for one currency-tenor combination, the
unsecured panel banks executed just 15 transactions of potentially qualifying size in the currency
funding markets and tenor for all of 2016
“The absence of active underlying markets raises a serious question about the
sustainability of the LIBOR benchmarks that are based upon these markets. If an active
market does not exist, how can even the best run benchmark measure it? Moreover, panel
banks feel understandable discomfort about providing submissions based on judgements
with so little actual borrowing activity against which to validate those judgements.”
Andrew Bailey, Chief Executive of the FCA (2017)

According to US Federal Reserve Bank data on daily USD unsecured funding volumes
(following money market reform), the median daily volume of 3-month funding (the
most heavily referenced LIBOR tenor) is less than USD1bn compared to more than
USD100tn in outstanding volumes of USD LIBOR contracts

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Why are IBORs being reformed? (contd.)

Panel banks have become increasingly reluctant to continue submitting quotes in

support of LIBOR in the absence of underlying transactions, due to concerns involving
potential litigation risk when they submit based on “expert judgement”

In 2016, one bank stopped submitting to the USD panel. In November 2017, another
bank stopped submitting to the USD panel and one bank stopped submitting to the
JPY panel
Panel banks’
reluctance to
submit quotes Since 2013, the EURIBOR panel decreased from 43 to 20 banks

In November 2018, the FCA issued a statement saying “All 20 panel banks have
provided their support until the end of 2021”. Query what happens post 2021 – will
the panel banks continue to voluntarily submit quotes?

Under the EU Benchmarks Regulation, regulators can compel submission for a period
of only two years

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Why are IBORs being reformed? (contd.)

EU supervised entities are prohibited from using a benchmark unless it included in

ESMA’s register
NB. It is possible for administrators/benchmarks to not satisfy the robustness
requirements. For example, EURIBOR will not be an approved benchmark from 1
January 2020
EU Benchmarks
Regulation
EU supervised entities need to have robust written plans setting out actions to take if
a benchmark materially changes/ceases to be provided (including using alternative
benchmarks)
NB. IBORs, as presently exist, do not have robust fallbacks

Systemic risk Uncertainty surrounding the durability of IBORs due to liquidity concerns and panel
robustness represents a potentially serious source of vulnerability and systemic risk

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Why are IBORs being reformed? (contd.)

Source: IBOR Global Benchmark Survey 2018 Transition Roadmap

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 – Introduction –
– What are IBORs? –
– Why are IBORs being reformed? –
– Alternative nearly risk free rates –
– Transitioning from IBORs to RFRs –
– Example financing structures –
– Implementing an effective IBOR transition –

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Alternative nearly risk free rates
• Working groups in each applicable jurisdiction have recommended robust, alternative nearly risk free
rates (RFRs) to transition away from existing IBORs
Characteristics
Working
Jurisdiction Alternative RFR Administrator Secured Year
Group vs. Description
published
unsecured
United Working Group Reformed Sterling Bank of Unsecured 2018 • Fully transaction-based
Kingdom on Sterling Risk- Overnight Index England • Encompasses a robust underlying market
Free Reference Average (SONIA) • Overnight, nearly risk-free reference rate
Rates • Includes an expanded scope of transactions to incorporate
overnight unsecured transactions negotiated bilaterally and those
arranged with brokers
• Includes a volume-weighted trimmed mean
United Alternative Secured Overnight Federal Secured 2018 • Fully transaction-based
States Reference Rates Financing Rate Reserve Bank • Encompasses a robust underlying market
Committee (SOFR) of New York • Overnight, nearly risk-free reference rate that correlates closely
(ARRC) with other money market rates
• Covers multiple repo market segments, allowing for future
market evolution

Europe Working Group Euro short-term European Unsecured October • Fully transaction-based
on Risk-Free rate (ESTER) Central Bank 2019 • Encompasses a robust underlying market of c. EUR30bn
Reference Rates • Overnight, nearly risk-free reference rate that reflects wholesale
for the Euro euro unsecured overnight borrowing costs of euro area banks
Area • Includes a volume-weighted trimmed mean
Switzerland The National Swiss Average SIX Swiss Secured TBC • Became the reference interbank overnight repo on 25 August
Working Group Rate Overnight Exchange 2009
on CHF (SARON) • Secured rate that reflects interest paid on interbank overnight
Reference Rates repo

Japan Study Group on Tokyo Overnight Bank of Japan Unsecured TBC • Fully transaction-based benchmark for the robust uncollateralised
Risk-Free Average Rate overnight call rate market
Reference Rates (TONA) • The Bank of Japan calculates and publishes the rate on a daily
basis, using information provided by money market brokers
known as “Tanshi”
• As an average, weighted by the volume of transactions
corresponding to the rate

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Alternative nearly risk free rates (contd.)

• There are key differences between the IBORs and RFRs, which will impact adoption and
fallbacks.

Characteristics IBORs Alternative RFR

Underlying Markets Since short-term interbank lending has shrunk considerably, To date, the underlying markets/transactions which
IBORs are not consistently reflecting a liquid underlying RFRs reference are very broad and liquid (e.g. repo
market. Rather, it is more accurate to say that IBORs reflect markets)
the “expert judgement” of panel banks

Tenors Multiple tenors are available (e.g. 1, 3, 6 months) Backward-looking overnight rates

NB. Forward curves still being developed

Credit spread IBORs include a credit spread since they reflect banks Broadly, no credit spread is included. Nearly risk-free
providing short-term financing to one another

Secured vs. Unsecured IBORs are based on unsecured lending transactions Some RFRs are based on unsecured lending (e.g.
Lending SONIA), but others are based on secured lending (e.g.
SOFRA)

NB. Differences between RFRs introduces potential

cross-currency basis risk

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Alternative nearly risk free rates (contd.)

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 – Introduction –
– What are IBORs? –
– Why are IBORs being reformed? –
– Alternative nearly risk free rates –
– Transitioning from IBORs to RFRs –
– Example financing structures –
– Implementing an effective IBOR transition –

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Transitioning from IBORs to RFRs

Contracts can be amended by one of

following:-
Option (i). Changing the existing IBOR
(e.g. LIBOR, EURIBOR) outright to an RFR.
NB. The market for RFRs is still developing.
This means that Option (ii) is more
practicable for the time being. Also,
exercising Option (i) will resulting in a
spread adjustment or a balancing payment.
Option (ii). Inserting fallback language
(e.g. ISDA Benchmarks Supplement in
ISDAs) to ensure a robust fallback to
address the possibility of the IBOR ceasing
to be published or the administrator no
longer being approved.
Ideally, all new contracts should reflect
RFRs rather than IBORs as the
applicable benchmark from the outset.
By doing so, a firm’s legacy book will be
“run off”.
However, in practice new contracts will
Legacy New
continue referencing IBORs given that
contracts contracts the new RFR definitions are being
finalised and that RFRs are still being
established (e.g. liquidity, forward
curve, operational aspects in banks).
Until this happens, the new contracts
will need to reflect Option (ii).

NB. If a fallback is exercised, this is likely to

result in a spread adjustment or a
balancing payment.

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Transitioning from IBORs to RFRs (contd.)
Transitioning from IBORs to RFRs (whether for new contracts or for including fallbacks in legacy
contracts) is not easy! As already explained, the two rates are fundamentally different

• Legacy contracts referencing IBORs • New Contracts

• Existing fallback arrangements (e.g. as specified in 2006 ISDA • Cash markets have only just begun
Definitions) were not designed for a permanent cessation of an IBOR issuing RFR-denominated debt. A key
• Two options – (i) amending to reference RFR rather than IBOR or (ii) concern is the lack of forward curves –
amending IBOR fallbacks to include RFR as fallback rate upon either an IBORs are available in multiple tenors
Index Cessation Event or an Administrator/Benchmark Event (e.g. 3-month), but RFRs are only
• (i) is probably not feasible given existing cashflows, so (ii) is more likely available on an overnight basis. Note
• Both (i) and (ii) are likely to result the inclusion of a spread to take into term structures are important for
account differences between the two rates – IBORs having more tenors products like syndicated loans and FRNs,
and the fact that they include a credit spread. Regardless, it is possible which are traded on the basis of known
that a price adjustment amount may still be payable by one party to the interest payments on the next IPD
other • Tenors and liquidity of derivatives
• Other issues referencing RFRs are presently nowhere
• Consents for amendments are likely to be needed in as extensive as for IBORs. This means
syndicated/secured deals (e.g. security trustee, bondholders) that using them for hedging purposes is
presently difficult
• Basis risk between interlinked products/positions
• New ISDA Definitions to include RFRs
• Disruption of hedging strategies
• Cross-currency basis risk due to differences between RFRs (e.g. some
are secured and others are unsecured)
• ISDA Benchmarks Supplement amending the 2006 ISDA
Definitions
• Compliance with EU Benchmarks Regulation

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 Transitioning from IBORs to RFRs (contd.)
How does the ISDA Benchmarks Supplement apply to a Derivatives Transaction referencing
an IBOR?
Administrator has ceased/will
cease to provide IBOR, whether
Index
permanently or indefinitely
(without any successor Cessation Event
administrator)
Apply any fallback already in the IBOR definition to
deal with an index cessation event.
NB. Contemplates the amendments which ISDA is
making to IBORs such as LIBOR and EURIBOR.
Priority
However, there may be a resulting adjustment Fallbacks
payment being paid by a party or an adjustment
spread being applied
If no fallback applies by the Cut-Off Date, then no-
fault termination of the Transaction on the basis of a
Termination Event with both parties being Affected
Parties (and in a 2002 ISDA, with the Termination
Event being “Force Majeure”)
NB. Termination right expires 10 Business Days if it
has arisen after any of the Alternative Continuation
Fallbacks were disregarded due to a dispute.
Thereafter, the Alternative Continuation Fallback can
be applied by the Calculation Agent.
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Administrator/ IBOR or its administrator is not
authorised/approved or included in
Benchmark an official register (e.g. for EU
Event Benchmarks Regulation purposes)
Alternative Continuation Fallback to be pursued in parallel prior to the
Cut-Off Date (but the first in hierarchy prevails):-
1. Parties agreeing to a solution
2. Applying the “Alternative Pre-nominated Index”, if any (but
needs to have been specified upfront)
3. Applying the “Alternative Post-nominated Index” for the IBOR, if
any (e.g. SONIA for LIBOR)
Alternative NB. Likely to result in either an “Adjustment Payment” being paid
by a party or an “Adjustment Spread” being applied to the
Continuation Transaction
Fallbacks 4. Applying a “Calculation Agent Nominated Replacement Index”
(i.e. the replacement index which the Calculation Agent thinks is
commercially reasonable)
NB. Likely to result in either an “Adjustment Payment” being
made or an “Adjustment Spread” being applied to the
Transaction)
No-fault
termination NB. The Cut-Off Date is 15 Business Days (subject to extension in
some circumstances).
NB. Ability to dispute Calculation Agent determinations. If dispute
cannot be resolved by agreement, the relevant Alternative
Continuation Fallback is ignored.
 – Introduction –
– What are IBORs? –
– Why are IBORs being reformed? –
– Alternative nearly risk free rates –
– Transitioning from IBORs to RFRs –
– Example financing structures –
– Implementing an effective IBOR transition –

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Example financing structures (contd.)

Simplified CMBS Structure

Noteholders

Floating Rate
Note Principal
Interest
Floating Rate Issuer-level
(EURIBOR) Trustee
Basis swap
counterparty
SPV Issuer
Floating
Rate
(EURIBOR)
Floating Rate
Loan
Interest
Floating Rate
(EURIBOR)
Loan-level swap
counterparty Lender
Fixed Rate

Fixed Rate Underlying Asset-level

Interest Loans Trustee

Underlying
borrowers

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Example financing structures (contd.)

• Original assumptions/pricing across the entire securitisation structure are fundamentally affected
by IBORs at any level (i.e. assets, hedging, liabilities) being changed
• Shifting to RFRs. If the IBORs do not shift at the same time, interest shortfalls could arise or
available excess spread could rise or fall
• Transfer of economic value. The potential credit effect will vary for creditors. Inclusion of
spread adjustments to eliminating/minimising any transfer of economic value, but this is
subject to negotiation
• Consents. Obtaining consents for amendments will be very challenging
• Consent of transaction parties (e.g. issuer, swap counterparty, cash manager, account
bank)
• Trustee is likely to seek noteholder approval. Consent thresholds vary and, in some cases,
may be set at 100%
• Where underlying assets have retail customers, then additional regulatory hurdles may
need to be overcome
• Market-facing positions. Swap counterparty may have market-facing positions, which also
need to be amended
• Future amendments. Subsequent amendments may be required in the future

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Example financing structures (contd.)

Simplified Loan Hedging Structure

Floating Rate Floating Rate Loan Interest

(LIBOR) (LIBOR) (LIBOR)
Market Hedge
counterparty counterparty
Borrower Lenders
Fixed Rate Fixed Rate

Market-facing Swap Hedging Swap Income Loan

Underlying
Assets

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 Example financing structures (contd.)

Simplified Investment Portfolio

IBOR-based
interest

Fund Lenders

IBOR-linked
Income Liabilities

Investment
X
X Portfolio
Market Hedge (e.g. bonds,
counterparties counterparties properties, fund
Y Y investments,
commodities)

Market-facing
positions Hedging strategies

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 – Introduction –
– What are IBORs? –
– Why are IBORs being reformed? –
– Alternative nearly risk free rates –
– Transitioning from IBORs to RFRs –
– Example financing structures –
– Implementing an effective IBOR transition –

www.bclplaw.com Page 27 © Bryan Cave Leighton Paisner

Implementing an effective IBOR transition
Identifying financial exposures
• Preparing inventory of existing trades and future
expected trades by asset class/exposure
• Understanding linked asset class/exposures (e.g.
hedges)
• Modelling IBOR “run-off” pre-2021 and IBOR “over-
hang” post-2022
• Contracts gathering
Launching RFR-linked products and building RFR
volumes (applicable to banks)
• External engagement with regulators and industry
working groups
• Ascertaining product design
• Obtaining requisite approvals/buy-in for product design
• Building RFR processes and infrastructure
• Customer communications and disclosures
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Defining IBOR transition programme
• Establishing governance structure for IBOR transition
programme (e.g. programme sponsor, group steering
committee, IBOR working group with all relevant
stakeholders)
• Agreeing transition policy (for both legacy portfolio and
new portfolio by reference to 2021). Identifying the
risks and implementing mitigants early (e.g.
communication strategy)
• Internal training/awareness
Transitioning back book/legacy contracts
• External engagement
• Product language analysis
• Determining negotiation strategy/playbooks and
manner of communications
• Negotiations with counterparties and customers
• Obtaining third-party consents
Questions

?
? ?
Beyond LIBOR – Implementing Benchmark
Reform
Tariq Zafar Rasheed, Partner
This document provides a general summary only and is not intended to be comprehensive. Specific legal advice should always be sought
in relation to the particular facts of a given situation.
Doc ID:- 67109128