LIBOR is a set of benchmark interest rates intended to represent the level at which major global banks borrow from and lend to one another in the international interbank market for short-term loans. LIBOR has been the most widely used interest rate benchmark in the world and has been called “the world’s most important number”. LIBOR is calculated and published daily across five currencies (USD, GBP, EUR, CHF, and JPY) and seven maturities or tenors (Overnight, 1 week, 1 month, 2 months, 3 months, 6 months, and 12 months) by ICE Benchmark Administration (IBA), the current administrator of LIBOR, and is based on rate quotation submissions by panel banks.
LIBOR is used as a rate index in a wide range of products globally, including residential mortgages, student loans, corporate loans, corporate bonds and other securities, and derivatives.
LIBOR has been a long-established global benchmark for interest rates, but its sustainability has declined over the past decade, because the market that LIBOR seeks to measure no longer is sufficiently active. During the financial crisis that began in 2007, LIBOR sometimes behaved in unpredictable and volatile ways. LIBOR has also proved to be vulnerable to manipulation, as was demonstrated by the rate rigging scandal brought to light in 2012. Although improvements have since been made to the governance of submissions, the volume of transactions supporting LIBOR continues to shrink, and the calculation of LIBOR is increasingly perceived as a subjective process based more on hypothetical transactions and judgment than actual transactions. Many banks have become uncomfortable providing submissions based on expert judgement, including some that have already chosen to stop submitting altogether.
In light of this situation, Andrew Bailey, the Chief Executive of the United Kingdom’s Financial Conduct Authority (FCA), publicly stated in a July 27, 2017 speech that the FCA would not persuade or compel LIBOR panel banks to make LIBOR submissions beyond the end of 2021, and subsequently obtained agreement from the existing panel banks that submissions will continue voluntarily through the end of 2021. The FCA is the UK regulator with oversight of the submission process used to generate LIBOR for various tenors.
The IBA announced on March 5, 2021 that it intends to (a) cease the publication of one week and two month USD LIBOR following the USD LIBOR publication on December 31, 2021, (ii) cease the publication of overnight, one, three, six, and 12 month USD LIBOR following the USD LIBOR publication on June 30, 2023 and (iii) cease the publication of GBP, EUR, CHF, and JPY LIBOR following their publication on December 31, 2021.
Subsequent to the IBA and FCA announcements, the Alternative Reference Rates Committee (ARRC) confirmed that it considered that these announcements constitute a Benchmark Transition Event under its recommended fallback language. The ARRC also affirmed prior supervisory guidance that new USD LIBOR issuances should cease no later than the end of 2021, specifically the joint supervisory statement issued on November 30, 2020 by the Federal Reserve Board (FRB), Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC). The joint statement encouraged banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable (and in any event not later than December 31, 2021) and to employ robust fallback language, and explained that the proposed extension would allow most legacy USD LIBOR contracts that are difficult or impossible to amend to mature before USD LIBOR experiences disruptions.
The two announcements constitute a benchmark transition or cessation event under certain contractual fallback provisions, including under the 2020 IBOR Fallbacks Protocol and Supplement published by the International Swaps and Derivatives Association (ISDA) to supplement the model documentation that it offers to govern derivatives transactions among market participants. The immediate effect of the occurrence of a benchmark transition or cessation event was to set the fallback rate spread adjustment (the 5-year historical median difference between the relevant LIBOR and its applicable fallback rate) provided for under certain fallback provisions. On March 5, 2021, Bloomberg, the organization chosen by ISDA to calculate and publish benchmark fallback adjustments, published a Technical Notice setting forth the spread adjustments applicable to all LIBOR settings across all LIBOR currencies.
You may receive a notice from us advising you of the occurrence of a benchmark transition or cessation event. The notice, however, will not result in an immediate move from LIBOR to a replacement benchmark rate under your agreement.
Different industry-led working groups were established in coordination with national financial regulators to recommend alternative reference rates to replace the different currency LIBORs and provide guidance on the transition away from LIBOR. The relevant working group in the United States is the ARRC. We encourage you to visit the ARRC’s website for informative reference materials, checklists and other resources.
It is important to note that the ARRC is not a regulatory body and does not have legislative or regulatory standard setting powers. The ARRC is a group of private-market participants convened to help ensure a successful transition from USD LIBOR to a more robust reference rate: its recommended alternative, the Secured Overnight Financing Rate (SOFR). The ARRC is comprised of a diverse set of private-sector entities, each with an important presence in markets affected by USD LIBOR, and a wide array of official-sector entities, including banking and financial sector regulators, as ex-officio members.
In response to recommendations and objectives set forth by the Financial Stability Board and the Financial Stability Oversight Council to address risks related to USD LIBOR, the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York (New York Fed) jointly convened the ARRC in 2014. The ARRC’s initial objectives were to identify risk-free alternative reference rates for USD LIBOR, identify best practices for contract robustness, and create an implementation plan with metrics of success and a timeline to support an orderly adoption of the identified alternative reference rates. The ARRC accomplished its first set of objectives and, in 2017, identified SOFR as its recommendation of the rate that represents best practice for use in certain new USD derivatives and other financial contracts. It also published a Paced Transition Plan, which has been revised several times, with specific steps and timelines designed to encourage adoption of SOFR.
The ARRC was reconstituted in 2018 with an expanded membership to help ensure the successful implementation of the Paced Transition Plan, address the increased risk that USD LIBOR may no longer be usable beyond 2021, and serve as a forum to coordinate and track planning across cash and derivatives products and market participants currently using USD LIBOR.
As noted above, given LIBOR’s shortcomings in recent years, more robust alternative reference rates have been recommended to replace LIBOR. LIBOR is published daily across five currencies (USD, GBP, EUR, CHF, and JPY), and an alternative reference rate has been recommended for each currency by the applicable national working group to replace the different currency LIBORs:
SOFR is the ARRC’s recommended (but not required) replacement rate for USD LIBOR. Wintrust is in the process of analyzing the selection of SOFR as a replacement rate. Both USD LIBOR and SOFR reflect short-term borrowing costs; however, there are some key differences between USD LIBOR and the alternative rates. For example, USD LIBOR is based partially on market-data “expert judgement,” whereas SOFR relies entirely on transaction data and is less subjective. USD LIBOR is forward-looking with seven (7) tenors ranging from one day to one year, while SOFR is a daily or “overnight” rate. USD LIBOR includes a built-in term credit-risk component because it is intended to represent the average cost among banks of term borrowings in the interbank market.
SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities. Per the ARRC, SOFR was recommended as the best alternative reference rate for USD LIBOR for the following reasons:
Within the context of LIBOR transition, “fallback language” refers to the provisions in a credit agreement or other financial contract that apply if the underlying reference rate (i.e., LIBOR) applicable to the product covered by that agreement or contract is discontinued or unavailable. Depending whether existing contracts contain LIBOR fallback language and how robust and specific that fallback language is, it may be necessary to update the fallback language used in contracts (or add it) for loans and other products that are indexed to LIBOR to ensure a smooth transition to a new rate upon cessation of publication of LIBOR.
Wintrust is performing an analysis of USD LIBOR exposure for each product line and is in the process of developing detailed and tailored transition plans.
If you participate in commercial loans, derivatives, residential mortgages, premium finance, or tailored lending with Wintrust, some of these products may have interest rates that are tied to LIBOR in some way or use LIBOR as a benchmark. This means that these products will need to be migrated away from LIBOR and indexed to an alternative rate instead, in order to eliminate exposure to LIBOR before its cessation.
Customers will need to understand why the industry is moving away from LIBOR, the alternative reference rates appropriate for use, and how these changes may impact new and existing LIBOR-linked contracts.
LIBOR is a set of benchmark interest rates intended to represent the level at which major global banks borrow from and lend to one another in the international interbank market for short-term loans.
SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities.
Tenor refers to the length of time remaining before a financial contract expires.
A panel bank commonly refers one of several banks that submit rates used to determine LIBOR.
1These FAQs are current only as of April 13, 2021. Please note these FAQs are solely for informational purposes and are not intended to provide legal, tax, accounting or financial advice. In making any decision relating to LIBOR transition, please consult with your legal, tax, accounting, or financial advisors, as necessary.