The global transition from the London Interbank Offered Rate ("LIBOR") and other interbank offered rates to alternative risk free rates ("RFRs") continues to be one of the biggest focuses and challenges for the financial services industry, including Canadian financial institutions and pension plans. Regulators and industry organizations around the globe have increased pressure on market participants to take steps to address the looming cessation of LIBOR in both new and legacy transactions.
As reported in a previous legal update in 2017, panel banks have reached a voluntary agreement to sustain LIBOR until the end of 2021. Notwithstanding the impact of COVID-19 on the global economy, the UK Financial Conduct Authority and the Bank of England have confirmed this 2021 deadline. Market participants should be preparing to reduce reliance on LIBOR and implementing reliance on alternative RFRs. As we approach the 2021 deadline, the Financial Stability Board ("FSB")1 released a transition roadmap on October 16, 2020 to outline the important milestones for a smooth transition from LIBOR to alternative RFRs.
Under the FSB recommended roadmap, by the end of 2020, the following steps should be accomplished:
- Identify and assess all existing LIBOR exposures;
- Identify other dependencies on LIBOR outside of its use in financial contracts;
- Agree on a project plan, including specific timelines and resources required;
- Understand industry or regulator recommended best practices;
- Assess what changes to supporting systems and processes are needed;
- Establish and implement communication plans with end-users of LIBOR referencing products maturing beyond 2021;
- Communicate to end-users of LIBOR referencing products maturing beyond the end of 2021 to ensure they are aware of the transition and steps taken to move these products to alternative rates;
- Where applicable, adhere to the ISDA Fallbacks Protocol and in the case of cleared and exchange-traded products linked to LIBOR, ensure equivalent fallback provisions are included; and
- Be in a position to offer non-LIBOR-linked loan products.
The FSB recommended roadmap suggests that the following steps should be completed by the middle of 2021:
- Establish formalized plans for legacy contracts where counterparties agree;
- Discuss with other parties how existing contracts, with LIBOR-linked exposures beyond the end of 2021, may be affected and steps to take;
- Implement the necessary system and process changes to transition to alternative reference rates;
- Use alternative reference rates in new contracts; and
- Take steps to execute formalized plans to convert legacy LIBOR-linked contracts to alternative reference rates
By the end of 2021, businesses should be in a stage where:
- All new business is conducted using alternative reference rates or provided for switching on limited notice;
- For legacy contracts that cannot be amended, discuss implications of cessation or lack of representativeness with the impacted parties; and
- All business critical systems and processes should be conducted without reliance on LIBOR or be capable of being changed at limited notice.
The FSB recommended roadmap follows a number of updates released through recent months in respect of transition from LIBOR and other interbank offered rates to alternative RFRs. Below, we have briefly summarized some of these key developments as they relate to interest rate benchmarks for Canadian Dollars, United States Dollars, British Pound Sterling and Euros relating to loan products:
- Canadian Dollars: As noted in a prior legal update, the Canadian Alternative Reference Rate Working Group ("CARR") was formed in March 2018 with the mandate to ensure Canada's interest rate benchmark regime is robust, relevant and effective in the years ahead. Initially, CARR's primary objective was to "support the adoption of, and transition to, the Canadian Overnight Repo Rate Average ("CORRA") as a key financial benchmark for Canadian derivatives and securities." The mandate of CARR was expanded on October 19, 2020 to include an analysis of the current status of the Canadian Dollar Offered Rate (CDOR) and its efficacy as an interest rate benchmark, as well as make recommendations based on that analysis. In June 2020, the Bank of Canada announced that it will be the administrator for CORRA. CARR is also considering the need to address transitioning away from CDOR in loan products.
- United States Dollars: In 2014, the Alternative Reference Rates Committee ("ARRC") was established by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York. ARRC's members include financial institutions, professional associations, trade organizations and government agencies. ARRC's mandate includes planning the transition to alternative references rates for United States Dollar interest determination, as well as identifying best practices for contract robustness in the interest rate market. ARRC has recommended that the Secured Overnight Financing Rate ("SOFR") be adopted to replace United States Dollar LIBOR. On August 27, 2020, ARRC published updated recommended hardwired fallback language for newly-originated United States Dollar LIBOR bilateralbusiness loans and noted in their best practices guidance that the hardwired fallback language should be incorporated by October 31, 2020. These updates to recommended hardwired fallback language and guidance on best practices follow similar revisions made by the ARRC to its recommended hardwired fallback language for newly-originated United States Dollar LIBOR syndicated loans (which was released on June 30, 2020). To assist with the transition, ARRC has also published a "SOFR Starter Kit" (which includes the history and background for USD LIBOR and SOFR, key facts about SOFR and SOFR Next Steps) and a technical reference document for syndicated loan conventions, which includes sample calculations of the different methodologies depending on how interest is calculated (e.g. simple vs. compounded, in arrears vs. in advance).
- British Pound Sterling: In 2015, the Bank of England established the Sterling Risk-Free Reference Rates Working Group ("RFRWG") in response to the FSB's 2014 report on interest rate benchmark reform and adoption of RFRs. On July 28, 2020, RFRWG released a statement on LIBOR transition, which included (i) a set of updated priorities for 2020-2021, including an updated roadmap; (ii) a Q&A in relation to the RFRWG's revised end-Q3 2020 milestones for loan markets; and (iii) a series of educational videos that provide background on the LIBOR transition. On September 1, 2020, RFRWG released a recommendation to support the transition to Sterling Overnight Interbank Average Rate ("SONIA") in respect of the standard market conventions for British Pound Sterling loans based on SONIA compounded in arrears.
- Euros: In September 2017, the European Central Bank (the "ECB"), the Belgian Financial Services and Markets Authority (FSMA), the European Securities and Markets Authority (ESMA) and the European Commission announced the launch of the private sector working group on Euro Risk-Free Reference Rates (the "Euro RFR Working Group") for the purpose of identifying and recommending RFRs that could "serve as a basis for an alternative to the current benchmarks." In 2018, the Euro RFR Working Group recommended the Euro Short-Term Rate (€STR) as the replacement for Euro Overnight Index Average ("EONIA"). €STR will be administered by the ECB and was published for the first time on October 2, 2019, reflecting trading activity on October 1, 2019. EONIA is anticipated to be discontinued on January 3, 2022. The ECB released a checklist on how to navigate the EONIA to €STR transition. It remains unclear whether Euro Interbank Offered Rate ("EURIBOR") will be discontinued upon the cessation of EONIA, but the Euro RFR Working Group is looking to identify €STR fallbacks for EURIBOR for a scenario in which EURIBOR may permanently cease to exist. Both forward and backward-looking methodologies for €STR are being considered by the Euro RFR Working Group. Based on the October 2020 newsletter from the Euro RFR Working Group, the final recommendations on EURIBOR fallback measures are expected to be announced by the end of Q1 2021.
As we approach the 2021 deadline for LIBOR cessation, there will be continued pressure put on market participants to adapt to best practices, recommendations and conventions released by regulators and industry organizations. Market participants should follow these developments closely and prepare their own playbook to ensure a successful and smooth transition to RFRs.
1 Financial Stability Board (FSB) is an international body aimed at promoting international financial stability through developing strong regulatory, supervisory and other financial sector policies. They coordinate national financial authorities and international standard-setting bodies from across 25 countries.
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