Move from LIBOR and other interbank rates to replacement interest rates
The London Interbank Offered Rate (usually referred to as (“LIBOR”) is expected to cease publication by the end of 2021, and will be replaced. Other key lending rates are expected to cease publication from that date or later, and will also be replaced.
Other existing interest rates are to be retained, but have been or are being reformed, and will co-exist alongside replacement interest rates.
What is LIBOR? What are interbank rates?
LIBOR is the interest rate at which banks lend to each other on a short-term basis. Banks can borrow in a number of currencies (US dollars, sterling, euro, yen and Swiss francs), for various different periods of time (ranging overnight to 12 months), and there is a different rate charged for each. In other financial centres around the world, other rates are charged between banks for borrowing, and are quoted by lenders (“interbank rates”), for example HIBOR in Hong Kong and TIBOR in Tokyo.
LIBOR is one of the most commonly used interest rates in global financial markets. It is used to determine the interest rate payable on a large number of loans, bonds, mortgages, derivatives and other financial contracts and investments, worth trillions of US dollars collectively. In other countries, local interbank rates may be used for certain similar purposes, although the volume of transactions is less than that of LIBOR transactions.
Why will LIBOR and other interbank rates no longer be published?
The LIBOR rate is based on submissions by a panel of banks, who quote the interest rates other banks will charge them to borrow money. These submissions used to be based on actual transactions but, since the global financial crisis of 2007-2009, the number of such transactions has greatly reduced in favour of alternative funding models. This lack of data has made LIBOR less reliable. Additionally, LIBOR has faced concerns regarding its reputation, since manipulation of quotes for the rates by some market participants was discovered to have taken place around the time of the Global Financial Crisis. In 2014, the Financial Stability Board recommended that LIBOR and other major interest rates be reformed or replaced. In 2017 the FCA announced that it was undesirable for market participants to rely indefinitely on reference rates that do not have active underlying markets to support them, and that the FCA would not compel banks to make LIBOR submissions after the end of 2021. Market participants generally understood this to mean that LIBOR would cease to the published after 2021. In 2018 and 2020 the FCA confirmed this view, and asked firms to plan a transition from LIBOR to replacement rates.
What are the replacement rates? Will some interbank rates continue?
Replacement rates will be based on a greater number of actual lending transactions, and will be calculated using transparent methods, administered by central banks, or administrators approved by them. The replacement rates are often referred to as “risk-free rates”, which may be abbreviated to “RFRs”. This is because the replacement rates do not include the amounts banks charge to cover the risk of lending to each other. Most replacement rates have been identified by joint working groups of market participants and regulators, and some are now traded in financial markets.
Financial regulators have determined that some interbank rates and other borrowing rates can be allowed to continue, since they have been sufficiently reformed to make them reliable. In most cases, reformed rates will co-exist alongside RFR’s, with regulators encouraging market participants to use each rate as appropriate (a “multi-rate approach”).
Below is a summary of some key interbank rates and their replacements, and certain interbank rates that will continue to exist alongside them:
The above table is not an exhaustive list and is provided for general informational purposes only.
What action is First Sentier Investors taking in relation to this transition?
We have established a group-wide project team to oversee the transition from LIBOR to replacement rates, which is working with all stakeholders across our organisation globally.
Within our funds and mandates, we invest in a wide range of instruments and assets which are linked to or have exposure to LIBOR and other interbank rates, and manage funds which have an objective linked to LIBOR. We will need to make changes to investments and objectives over time to reference replacement risk-free rates. As the manager of these portfolios, we always strive to achieve an outcome that is in the best interests of our clients.
Our transition efforts will be aligned with market practice and comply with applicable laws and regulations, and take into account relevant regulatory guidance. We will seek to minimise any impact on our clients and investors
You do not need to take any action and we will inform you of any planned changes to the investment objectives of our funds before they take place. We shall also inform you if there are any future developments which may affect you materially.
For more information on this transition, please refer to our FAQs.
How can I receive further information?
Please contact [email protected].
Further information is also available from these sources:
- the UK FCA: https://www.fca.org.uk/markets/libor
- the Investment Association: https://www.theia.org/campaigns/libor
- the US Alternative Reference Rates Committee (ARRC), in respect of USD LIBOR and its replacement, SOFR: https://www.newyorkfed.org/arrc
- the International Swaps and Derivatives Association (ISDA), in relation to derivatives: https://www.isda.org/2020/05/11/benchmark-reform-and-transition-from-libor/
- the International Capital Market Association (ICMA), in relation to bonds: https://www.icmagroup.org/Regulatory-Policy-and-Market-Practice/benchmark-reform/
- the Loan Market Association (LMA), in relation to loans: https://www.lma.eu.com/libor
This material is not intended to be relied upon as a forecast, research or as legal, regulatory or, investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of November 2020 and may change as subsequent conditions vary.
The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by First Sentier Investors to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by First Sentier Investors, its officers, employees or agents. This material may contain “forward-looking” statements which may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.
All financial investments involve an element of risk. Therefore, the value of your investment and the income from it will vary and your initial investment amount cannot be guaranteed.
Issued by First Sentier Investors (UK) Funds Limited which is authorised and regulated by the Financial Conduct Authority (registration number 143359). Registered office Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB number 2294743. A member of MUFG, a global financial group.