This newsletter is a follow-up of the LIBOR - $OFR Transition webinar hosted by DEG, FMO and Proparco on 13 October 2020.
While we will organize a second webinar later this year, in this newsletter we would like to inform you on the most recent market developments regarding the replacement rate for LIBOR, while also updating you on our institutional preparations and response to these developments.
On 5 March, the UK Financial Conduct Authority announced (“FCA”) new dates for the cessation or loss of representativeness of 35 LIBOR benchmark settings currently published by ICE Benchmark Administration (IBA). Publication of all LIBOR settings will cease after 31 December 2021 except for 1-month, 3-month and 6-month USD LIBOR which will continue to be published until 30 June 2023 for legacy LIBOR loans. This is to provide a smooth transition of existing LIBOR contracts. The FCA encourages banks to stop originating new LIBOR loans as soon as possible, but no later than 31 December 2021. This decision has been commended by the Alternative Reference Rate Committee (“ARRC”).
Contrary to earlier expectations and communication by ARRC, there will not be a SOFR term rate available by mid-2021. The ARRC also cannot guarantee that it will be in a position to recommend an administrator that can produce a robust forward-looking term rate by the end of the year, meaning that market participants are recommended to not rely on a SOFR term rate to be available in 2021.
As a quick refresher on the rationale for having an adjustment spread: LIBOR includes a credit element to reflect the cost and risk for banks, to borrow for a certain tenor. As SOFR is an overnight rate, the risk of lending is lower, meaning that SOFR is lower than LIBOR. To ensure a fair conversion of existing contracts, an adjustment spread is needed to compensate for these differences.
Even though the adjustment spread was published daily by Bloomberg until recently, it is fixed per 5 March 2021. Both the International Swaps and Derivitatives Association ("ISDA") and the ARRC have announced that they will use this static spread adjustment going forward and the loan market association ("LMA") is aligned with this approach. For further information, please check the ARRC adjustment spread methodology.
While there is no clear market consensus yet, SOFR compounding in arrears (observation shift, compatible with SOFR Index and the derivatives market) remains the most likely alternative interest methodology for USD LIBOR now.
In view of the postponed cessation of USD LIBOR until 30 June 2023, the second LIBOR - SOFR transition webinar for our customers will follow later this year. We will provide more details on registration in the future.
The shifted deadlines for USD LIBOR have been considered when preparing to transition away from USD LIBOR for the existing loan contracts. Based on the current available information, the transition will have to be completed by mid-2023. The exact start of the transition process may slightly differ per institution and customer, but remains to be determined.
Timing may differ per institution when it comes to providing SOFR loans and depends on various factors, including market consensus and system availability. However, we aim to comply with ARRC recommendations not to provide new USD LIBOR contracts after 31 December 2021.
For additional information, please reach out to your relationship manager at DEG, FMO or Proparco or consult the following websites:
The content of this newsletter is based on currently available public information; it shall not be considered exhaustive, and it could change in the future. The disclosed information shall not in any case be considered or taken as advice provided to its recipients.