Market Updates On The LIBOR Transition

This year will be key in the London Inter-Bank Offered Rate (LIBOR) transition. After consultation on ending the publication of LIBOR in USD, GBP, EUR, CHF, and JPY, the administrator of LIBOR, the ICE Benchmark Administration (IBA), may announce its decision soon. The announcement of LIBOR cessation would trigger the spread adjustment to be fixed as a component of the LIBOR fallback rate for derivatives contracts with fallback provisions governed by ISDA.1 For legacy non-consumer cash products referencing USD LIBOR, this fixed spread adjustment would be added to a form of SOFR to replace USD LIBOR as recommended by the ARRC.2

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IBA’s consultation in December 2020 indicated its intention to cease the publication of LIBOR in GBP, EUR, CHF, and JPY, as well as 1-week and 2-month USD LIBOR at the end of 2021, along with major USD LIBOR tenors (overnight, 1-month, 3-month, 6-month, and 12-month) in June 2023. Despite the potential delay of USD LIBOR cessation to mid-2023, U.S. regulators are encouraging no new USD LIBOR contracts after the end of 2021, while allowing most legacy contracts to mature before USD LIBOR stops.

On derivatives contracts, progress has been made in LIBOR transition with the ISDA 2020 IBOR Fallbacks Protocol having taken effect on Jan. 25, 2021. The ISDA leads the initiative to improve the derivatives contract robustness to address the risk of LIBOR discontinuation. The ISDA’s protocol provides standard fallback language for IBOR-based derivatives (including LIBOR) on a voluntary basis. It lays out a clear path to transition to replacement rates for the USD 200 trillion USD LIBOR derivatives market.

The other milestone in listed derivatives’ LIBOR transition also took place on Jan. 25 when CME provided details on the proposed methodology for transitioning Eurodollar futures and option contracts. Because of Eurodollar futures and options’ close relation to OTC LIBOR-based derivatives, CME aligns with ISDA in its Eurodollar futures and options fallback language. Upon a fallback trigger, Eurodollar futures would be converted to 3-month SOFR futures, with prices adjusted in line with the ISDA approach. Eurodollar futures options would be replaced with corresponding 3-month SOFR options, with strike adjusted using ISDA’s spread adjustment.

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