Now here we are 2 years later with just over 6 months to go until USD LIBOR’s demise. And those planning their Thanksgiving dinners this week can be grateful that things seem to be pretty much on track (though we can’t completely rule out a spot of indigestion).

So how does USD cessation 6 months out compare to where we were with Sterling at the equivalent juncture (and 6 months on from our last review, USD LIBOR – the sequel)?

Short answer is things seem to be in fairly good shape – SOFR[2] liquidity has built in derivatives, there hasn’t been any new USD LIBOR for nearly a year now (other than permitted hedging), fallback protocol for derivatives is almost universally adhered to, and there has been regular SOFR bond issuance. There is even legal safe harbour to apply ARRC[3] sanctioned fallbacks for US law governed contracts in the form of the federal LIBOR Act.

Probably the one to watch, just like 6 months out in £, is the ‘loan tail’ – there will likely be a last minute scramble to get loan documentation amended to include fallback/switch language to SOFR. Finally one area of some controversy seems to be Term SOFR – in use in the cash markets (especially loans) but not permitted (per ARRC guidelines) for derivatives except for direct hedging of Term SOFR underliers, leaving a basis between Term SOFR and compounded-in-arrears SOFR for the interbank market to manage (without a Term SOFR interbank swap market).

Quick run down below on the main points per asset class, then we dig a bit deeper into the similarities and differences between Sterling and Dollar transition. Wrap up with a reminder on the conventions in use for compounding, and a shameless plug for our RealisedRate.com calculator, which has seen usage go from strength to strength with the wider adoption of RFRs[4]. 

• Derivatives: wide adoption of SOFR now (latest ARRC minutes have usage stats, including 90% new swaps in SOFR); most USD LIBOR swaps either cleared (and subject to CCP[5] transition plans in Q1/Q2 2023 – see LCH and CME) or subject to fallback protocol; note the extra 2022 protocol for CMS[6]/Swaptions referencing $ LIBOR ICE[7] Swap Rate (ISR); some bilateral derivatives, e.g. loan linked swaps, will require bilateral fallback agreement.
• Bonds: FRN[8] issuance in SOFR by financial institutions (FIs) has steadily increased throughout 2022 (see ARRC readout); there has been some commentary in the press on limited SOFR uptake by NFCs[9], however in the context of most corporate issuance being fixed rate anyway that may not be significant; for US law governed issuance, contracts without fallbacks can depend upon the LIBOR Act to support the ARRC waterfall replacement rates (with Term SOFR at the top for cash); non-US law bonds will require transition/amendment if robust fallbacks are not in place.
• Loans: perhaps the furthest still to go; the path and options are clear, and as with bonds if US law then there is a legal safe harbour; less certain whether there will also be a USD LIBOR synthetic rate post cessation – most likely, as with GBP, it will be left to a last minute announcement; but both bilateral and syndicated loans will for the most part be repapered, and that is quite a resource-intensive process with time running out; recent loan remediation survey by ARRC indicated that >50% expect majority of their loans to transition only by end Q2, '23, or will use fallbacks at cessation.

This is a difference between USD and GBP – Term SONIA[10] is only permitted by the FCA[11] under fairly narrow conditions relating mainly to Trade Finance. In US, ARRC has published best practice guidelines permitting wider use of Term SOFR across cash markets, and it is emerging as the de facto standard for loans as the replacement for USD LIBOR. It is also acknowledged at the top of the waterfall logic for fallbacks for cash products. 

It is not permitted for use in derivatives market except where the Term SOFR swaps are direct hedges for Term SOFR underliers. So there is deliberately no developing Term SOFR interbank swaps market, though that does leave banks offering Term SOFR hedges for loans for example with basis risk between Term SOFR and SOFR-In-Arrears to manage. 

ARRC has made quite a point recently of reinforcing the guidelines – for example in the latest read out from ARRC progress meeting in November: “The ARRC expressed concern about some recent trends, such as securitisations using Term SOFR when they did not have underlying Term SOFR assets, that were outside the scope of the ARRC’s best practice recommendations.”

Another difference to the UK. The US is enacting the Adjustable Interest Rate (LIBOR) Act which provides for transition to a replacement rate selected by the Federal Reserve in the event of no fallback being in place, and protection from liability for parties applying those rates. However this would only apply to US law-governed contracts.

For the rest of the world with contracts referencing USD LIBOR, the path for ‘Tough Legacy’ will likely be the same as for GBP LIBOR. In the case of Sterling just prior to cessation, the FCA instructed ICE to start to publish a ‘synthetic LIBOR’ rate based on Term SONIA + Credit Adjustment Spread (CAS). That meant whatever legacy contracts that were still left on LIBOR in January 2022 could still fix and settle.

Just as we were going to press with this article the FCA announced that they are consulting on requiring ICE to continue publishing synthetic USD LIBOR rates for  1-, 3- and 6-month tenors until end of September 2024.  Important difference here to the LIBOR Act for US law governed contracts is that it is a time limited period to reference a synthetic rate, not a permanent fallback solution.  For synthetic GBP LIBOR the FCA has already announced they are withdrawing 1- & 6-month settings in March 2023, and have just confirmed that 3-month will be withdrawn end March 2024.

Back in the mists of time pre-COVID (Dec 2019) we wrote a piece called Compounding the problem with conventional wisdom, which has ended up being one of our more popular articles which people continue to refer back to. We paste below an updated version of the table of conventions we presented then. 

Things to note for the US:

• Term SOFR is the emerging standard for loans
• 2d shift emerging as the main standard for SOFR FRNs, but still some variance

When we put this piece out originally, we had recently launched our free-to-use RFR calculator www.RealisedRate.com. Over 3 years on from launch in July 2019 the tool is still running, and is more used now than ever – please give it a try to help with calculating compounded rates in arrears, and let us know what you think.

So that is about it for USD – expect a busy time in the run up to transition in Q1 / Q2 2023 with the CCP transition weekends, and the tying down of remaining documents and transition plans. But broadly things are playing out as expected following the path already trodden by GBP. Of course one final difference is the sheer scale of it – there are many more USD LIBOR referencing contracts out there than there were GBP.

And in the rest of the world the LIBOR rates that have already ceased are managing down a small tough legacy tail. Per our earlier comment, GBP Synthetic LIBOR rates for 1m and 6m are due to be withdrawn on 31 March 2023, with 3-month following suit on 31 March 2024.  Anyone who still has any contracts referencing these tenors needs to transition those deals asap.  

Other IBORs[12] such as SOR[13] (which is partly dependent upon USD LIBOR for its construction) will move to ‘Fallback SOR’ on 30 Jun 2023 as an interim measure (assuming fallback protocol in place), prior to moving finally to SORA when Fallback SOR is withdrawn on 31 Dec 2024.

EURIBOR[14] is the clearest outlier now for IBORs – there has been no mention yet within the EU about planning for its withdrawal, but we do wonder whether once USD LIBOR is no more, then the focus may move in this direction.

Happy Thanksgiving to those celebrating it!

* It’s difficult to explain all the permutations and exceptions in a brief table, so above aims to give a flavour of the main blocks & usage, without being exhaustive.

 

[1] LIBOR: London Inter-Bank Offered Rate

[2] SOFR: Secured Overnight Financing Rate

[3] ARRC: Alternative Reference Rates Committee

[4] RFR: Risk-free rate

[5] CCP: Central Clearing Counterparty

[6] CMS: Constant Maturity Swap

[7] ICE: Intercontinental Exchange London

[8] FRN: Floating-rate note

[9] NFC: Non-Financial Counterparty

[10] SONIA: Sterling Overnight Index Average

[11] FCA: Financial Conduct Authority

[12] IBOR: Inter-Bank Offered Rates

[13] SOR: Singapore Dollar Swap Offer Rate

[14] EURIBOR: Euro Interbank Offered Rate