Since the 1st of January 2022 only a limited amount of GBP and JPY London IBOR’s (“LIBOR”) are published (the so called “synthetic LIBOR’s). The UK’s Financial Conduct Authority has clarified that the continuation of such synthetic LIBOR’s will be reviewed annually.
Taking into account the cessation of the LIBOR rates (with the remaining 5-US LIBOR’s only guaranteed to continue until mid-2023) the emphasis is that transition is required to different risk free rates such as SOFR (USD), €STR (EUR) and SONIA (GBP). The reason for this transition to a new benchmark stems from a number of abuses in the setting of IBORs. These abuses led to the creation of the EU Benchmark Regulation ((EU) 2016/1011) (Benchmark Regulation). A statement of the Working Group on Euro Risk Free Rates in December 2021 reemphasizes the importance of further transitioning.
For the financial practice (and the financial world as a whole), the transition to benchmarking entails a number of far-reaching changes. Not only do parties active in the financial markets have to start using new (often unknown) benchmarks, but also existing agreements have to be adjusted because the existing references to interest rate benchmarks no longer provide the necessary clarity. Furthermore, organisations and systems have to be prepared for the use of new interest rate benchmarks.
In this article, we discuss some recent (inter)national developments with respect to the transition to interest rate benchmarking. In addition, we indicate which steps need to be taken by market parties in order to be well prepared for the end of the existing IBORs.
Statement by the Dutch Central Bank and the Netherlands Authority for the Financial Markets
DNB and AFM have published a joint statement at the end of 2021 in which they point out to market participants their responsibilities regarding the benchmark rate-transition:
- there are still many agreements in use that are based on LIBOR or EONIA and that have not yet been adjusted. This may become problematic because these benchmarks will no longer be published after 31 December 2021, agreements need to be adjusted as a matter of urgency;
- new agreements should consistently refer to an approved benchmark under the Benchmark Regulation, this requires adaptation of existing contract documentation (templates);
- parties must take sufficient measures to protect themselves against the possible loss of a benchmark by adjusting the provisions used in old and new agreements (also a requirement under Article 28(2)(e) Benchmark Regulation), robust fallback options must be included in agreements by 31 December 2021;
- relevant (contract) parties should be informed about changes as consequences of such a transition and how the changes will affect the specific counterparties.
AFM recommendations to mitigate conduct risks of benchmark rate-transition
The AFM and DNB have indicated that a number of banks, insurers and pension funds are struggling with how to incorporate so-called fallback options in relation to the benchmark rate-transition in their (existing and new) contracts. It is partly in this context that the AFM, in addition to the joint statement by the AFM and DNB referred to in the previous paragraph, has published a number of recommendations regarding the limitation of conduct risks resulting from the benchmark rate-transition. This concerns risks arising from differences in knowledge and negotiating power between financial institutions and their customers (as stated by the AFM) and interim changes to product (terms and conditions).
The recommendations of the AFM include:
- formulating a robust set of fallback options as soon as possible and including them in (existing and new) agreements;
- ensuring clear communication with contractual counterparts and customers as soon as possible regarding the consequences of, and necessary steps to be taken in relation to, the benchmark rate-transition;
- setting up internal steering committees to ensure that the transition takes place in an orderly and efficient manner;
- due diligence on the impact of the benchmark rate-transition on existing agreements and identifying and implementing the actions needed to make agreements benchmark rate-transition-proof;
- identifying operational risks and implementing risk mitigating measures, such as adjusting IT systems, etc.
Statements by European regulators
In a joint statement of the European Central Bank, the European Commission and the European Banking Authority, it is emphasized that LIBOR should no longer be used as reference rate and that the use of synthetic LIBOR variants should be limited as much as possible. In addition, they also draw the attention of parties to the obligation under Article 28 (2) Benchmark Regulation to include robust fallback solutions in respect of reference interest.
In this context, we also refer to previous recommendations published in May 2021 by the ECB regarding fallback triggers for €STR and EURIBOR agreements for an overview of possible actions to be taken.
Financial Conduct Authority statement on LIBOR
Most LIBOR benchmarks have ceased to exist. Of the remaining LIBOR benchmarks, it is clear that they will end soon. The UK’s Financial Conduct Authority has clarified that ‘synthethic’ LIBOR’s are only guaranteed until the end of 2022. In addition, the USD LIBOR’s will also most likely be discontinued in June 2023 (as set forth in the next paragraph).
The following ‘synthethic’ LIBOR’s are still available:
1 month Sterling LIBOR
1 month Japanese Yen LIBOR
3 months Sterling LIBOR
3 months Japanese Yen LIBOR
6 months Sterling LIBOR
6 months Japanese Yen LIBOR
The FCA does emphasise that these synthetic options will be available for a very short transition period in order to protect so-called "tough legacy" agreements and to enable a transition for these agreements. The FCA encourages parties to make plans to avoid complications if these temporary synthetic LIBOR benchmarks are no longer continued.
US and benchmark rate transition
Regulators and the Benchmark Administration Limited in the US announced at the end of 2020 that with respect to one- and two-week settings, the transition will take place at the end of 2021. For all other settings (overnight and one, three, six or twelve months) only on 1 July 2023 will the publishing of the benchmark rates no longer be obligatory and as a result they are likely to no longer be available.
In March 2021, the Federal Reserve Bank published guidelines for financial institutions on benchmark transition. In summary, these guidelines address: (1) sound transition planning, (2) financial exposure and risk assessment measures, (3) operational preparedness and control mechanism, (4) legal contract preparedness (5) communication and (6) oversight.
If you have not yet taken measures regarding the possible impact of the benchmark rate-transition on your organisation, and in particular the external and internal financing arrangements, we advise you to take action quickly.
The first step will be to identify which internal and external financing documentation needs to be adjusted. Based on this inventory, an action and communication plan should be drawn up and the relevant agreements should be amended.
Meijburg and your benchmark rate-transition
We will be happy to assist you in preparing and implementing your benchmark rate-transition. Our multidisciplinary team of tax and legal specialists could assist you with:
- analysing the impact of the benchmark transition on your organisation;
- tax (transfer pricing) advice on existing (intra-group) financing arrangements;
- due diligence on existing financing documentation and inventory of interest agreements;
- repair of documentation; modification of existing (intra-group) loan documentation (shareholder loans and cash pool arrangements);
- financial regulatory advice on the Benchmark Regulation;
- updating internal procedures and guidelines.
Should you have any questions regarding this contribution or should you wish to receive further advice? Please feel free to contact Matthijs Bolkenstein (+31 6 466 30 866), Michiel Jaeger (+31 6 53106615) and Floris-René van Strien (+31 6 15 00 83 94).
Please note that we also have transfer pricing and tax specialists at Meijburg & Co who can assist you with the broader tax impact of the Benchmark rate-transition. For more information about how to deal with the Benchmark rate-transition from a transfer pricing perspective, please click here.