Frequently Asked Questions
1. General information
1.1 What are reference rates?
A reference rate is an interest rate benchmark used to set other interest rates or to determine pay-offs in a financial contract and which is outside the control of the parties to the contract. Interest rate benchmarks are essential for the smooth functioning of the financial markets and are widely used by banks and other market participants. Various types of transactions use different interest rate benchmarks, but the most common are LIBOR and EURIBOR. Reference rates are used in many different contracts like floating rate notes, loans, swaps, short-term interest rate futures contracts and debt capital markets instruments, as well as homeowner mortgages.
1.2 What is happening to the current benchmark rates?
Due to international agreements and European Benchmarks Regulation a number of well- known and widely used interest rate benchmark indices are reformed or expected to be discontinued and replaced with alternative, risk-free rates. This may have significant impact on client transactions.
1.3 Why are the benchmark rates being replaced?
Benchmark interest rates like LIBOR, EURIBOR and EONIA were originally based on interbank borrowing/lending transactions. Since the financial crisis of 2008 the liquidity in the interbank market has significantly decreased. This has raised concerns regarding the representativeness of the benchmarks whilst at the same time the volume of contracts dependent on these benchmarks (for example interest rate derivatives) has substantially grown. The way in which current benchmarks are established - through submissions from panel banks, which are often based on the (subjective) assessment of a trader in the absence of observable trades - is also a cause for concern. Therefore regulators and central banks have requested the financial industry to design and implement alternative, transaction-based risk-free reference rates to better and more robustly reflect market conditions. Benchmarks that are used in the EU need to comply with EU Benchmarks Regulation. The current EURIBOR benchmark has been made compliant in 2019. The current EONIA benchmark is not compliant with this regulation and will be replaced with €STR.
2. LIBOR transition
2.1 What is LIBOR?
LIBOR stands for London Inter-Bank Offered Rate and provides an indication of the average rate at which LIBOR panel banks could obtain wholesale, unsecured funding. The rate is calculated for 5 five different currencies (USD, GBP, EUR, CHF, JPY) and for different tenors ranging from overnight to 12 months. It is based on submissions from a panel of contributing banks and administrated by ICE Benchmark Administration (ICE BA) in London. LIBOR is used in retail and professional markets, amongst others for lending transactions, in floating rate bonds and in derivatives.
2.2 What is happening to LIBOR?
The Financial Conduct Authority (FCA), the regulator overseeing LIBOR, has publicly stated that it will no longer require banks to participate in the LIBOR panel after 31 December 2021. In addition, the ICE BA(i.e. the administrator of LIBOR) is currently consulting on its intention to cease publication of the different LIBOR settings as per two separate dates.
Immediate cessation following LIBOR publication on December 31, 2021 for:
- GBP LIBOR - all settings (overnight, 1 week, 1, 2, 3, 6 and 12 months)
- EUR LIBOR - all settings (overnight, 1 week, 1, 2, 3, 6 and 12 months)
- CHF LIBOR - all settings (spot next, 1 week, 1, 2, 3, 6 and 12 months)
- JPY LIBOR - all settings (spot next, 1 week, 1, 2, 3, 6 and 12 months)
- USD LIBOR – 1 week and 2 months
Immediate cessation following LIBOR publication on June 30, 2023 for:
- USD LIBOR – overnight and 1, 3, 6 and 12 months settings
In the meantime, global regulators and the industry are working together to facilitate the transition to alternatives of each of the affected LIBOR currencies (EUR, GBP, JPY, USD and CHF).
2.3 What are the recommended alternatives for the different LIBORs?
Several authorities and industry working groups have all identified recommended alternatives to the different LIBORs. For each of these LIBORs and the recommended alternative risk free rate, the transition is at different stages and continues to further evolve. The following risk free rates are considered as recommended alternatives for the different LIBORs:
- USD LIBOR replaced by ‘Secured Overnight Finance Rate (SOFR)’ which is the cost of borrowing cash overnight collateralized by US Treasury securities
- GBP LIBOR replaced by ‘reformed Sterling OverNight Index Average (SONIA)’ which is the effective overnight interest rate paid by banks for unsecured Sterling transactions
- CHF LIBOR replaced by ‘Swiss Average Rate OverNight (SARON)’ which is the overnight interest rate of the secured funding market for Swiss Franc
- JPY LIBOR replaced by ‘Tokyo OverNight Average Rate (TONAR)’ which is an uncollateralized overnight call rate
- EUR LIBOR replaced by ‘Euro Short Term Rate (€STR)’ which is the wholesale euro unsecured overnight borrowing costs of banks located in the euro area (also refer to Section 3 EONIA transition)
2.4 Will forward-looking term risk free rates be introduced?
Since LIBOR is a forward looking rate that is available in a number of tenors, several industry working groups have announced their willingness to develop forward looking term risk free rates. The development of these rates differs and continues to evolve over time:
- SOFR – the Alternative Reference Rate Committee (ARRC) envisages the publication of forward looking term SOFR rates in the first half of 2021 if liquidity in SOFR derivatives markets has developed sufficiently
- SONIA – although the Sterling Risk Free Rate Working Group (RFRWG) prefers adoption of SONIA compounded in arrears, as of January 11 2021, the publication of three different forward looking term SONIA rates has been announced (FTSE, Refinitiv, IBA). The UK regulator may restrict use of these SONIA rates to specific products and/or clients.
- SARON – the National Working Group on Swiss Franc Reference Rates (NWG) does not recommend the use of a forward looking term rate
- TONAR – the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks published prototype term rates, but the actual term rate is not expected until mid-2021
2.5 LIBOR transition - What impact does this have on you?
It is expected that USD LIBOR overnight and 1, 3, 6 and 12 months settings will continue to be published until June 2023, whereas all other settings (i.e. all GBP/EUR/CHF/JPY LIBOR settings and USD LIBOR 1 week and 2 months settings) will be published until December 2021. Rabobank is closely following market developments and regulatory publications with regard to the benchmark transition and will continue to offer products and services in line with market practice. We encourage you to make preparations and to seek appropriate advice on ramifications resulting from the phase-out of LIBOR. Examples of things to consider at this time are amongst others: whether contracts you enter into at this time contain robust legal mechanisms for the situation where the referenced benchmark is discontinued and whether the systems you use to administer the transactions which reference IBORs are able to handle new alternative rate benchmarks.
3. EONIA transition
3.1 What is EONIA?
EONIA stands for Euro OverNight Index Average and is the effective overnight reference rate for the euro. It is computed as a weighted average of all panel banks’ overnight unsecured lending transactions in the interbank market, undertaken in the European Union and European Free Trade Association (EFTA) countries. Its administrator is EMMI in Brussels and the European Central Bank (ECB) is the calculation agent. EONIA is primarily used in the professional market for amongst others valuations and for calculation of margin and collateral obligations.
3.2 What is happening to EONIA?
The ECB publishes the €STR (Euro Short Term Rate). As of 2 October 2019, EONIA is calculated as €STR plus a fixed spread of 8.5 basis points and has therefore become in effect a tracker of the new €STR benchmark. EONIA will no longer be published after 3 January 2022 and solely €STR will be published as of that moment.
3.3 EONIA transition - What impact does this have on you?
For now your financial instruments and products, which reference EONIA (now calculated as €STR + spread), remain available and the references to EONIA remain unchanged. If applicable, we will contact you about changes to your contractual relationship with us, in due course. At a product level Rabobank is monitoring market developments as well as recommendations made by relevant working groups which are relevant to EONIA and €STR.
4. Redefined EURIBOR
4.1 What is EURIBOR?
EURIBOR is an unsecured market benchmark rate calculated for several tenors(one week, and one, three, six and twelve months). It is administered by the European Money Markets Institute (EMMI).
4.2 What is happening to EURIBOR?
In line with its obligation under the EU Benchmarks Regulation European Money Markets Institute (EMMI), the provider of EURIBOR, has strengthened the approach for the daily determination of EURIBOR. EMMI has requested and obtained approval for this new EURIBOR calculation methodology from the relevant regulator and announced that it had completed the phase in of this new methodology. At the time of writing the industry expectation is that reformed EURIBOR will remain in place in the near term, a move away from EURIBOR could still occur somewhere in the future.
4.3 EURIBOR transition - What impact does this have on you?
As mentioned above, the relevant regulator has authorized the continued use of EURIBOR, although with an updated calculation methodology. So, as opposed to many of the IBORs, the EURIBOR benchmarks will continue to exist for the foreseeable future, meaning that there is no immediate risk of a major disruption for contracts relying on EURIBOR fixings. Nonetheless, contracts should include robust fallback language to account for the eventuality that EURIBOR is discontinued in the future. Rabobank may reach out to you in due course if it considers that amendment of your contract should be preferable.
5. SIBOR, SOR and HIBOR transition
5.1 What are SIBOR, SOR and HIBOR?
SIBOR stands for Singapore Inter Bank Offered Rate. An individual bank contributes the rate at which it could borrow funds in SGD (Singapore Dollar), were it to do so by asking for and accepting the interbank offers in reasonable market size.
SGD SOR stand for Singapore Swap Offer Rate and is defined as the synthetic rate for deposits in SGD, which represents the effective cost of borrowing the SGD synthetically by borrowing USD for the same maturity, and swap out the USD in return for the SGD.
HIBOR, or Hong Kong InterBank Offered Rate, is the annualized rate charged for inter-bank lending on Hong Kong Dollar (HKD) denominated instruments, for a specified period ranging from overnight to one year.
5.2 What is happening to SIBOR, SOR and HIBOR?
In Singapore, SGD SOR will be replaced by SORA (Singapore Overnight Rate Average) for derivatives and some cash market products. Also SIBOR will be replaced by SORA. It is planned that SIBOR will be discontinued by end-2024 for 1-month and 3-month SIBOR and three months after the discontinuation of the 6-month SOR for 6-month SIBOR.
In Hong Kong, HIBOR has been subject to reforms to enhance its transparency and robustness and may be subject to further reforms in the future. Reforms to HONIA (Hong Kong Dollar OverNight Index Average) as the alternative risk free rate for HIBOR, to further strengthen its representativeness are currently being considered. Presently a multiple rate approach is expected and HIBOR is expected to co-exist with HONIA.
5.3 SIBOR, SOR and HIBOR transition - What impact does this have on you?
Consultations are on-going and potential reforms are being considered by local regulators in Singapore and Hong Kong respectively. Rabobank is monitoring these developments closely and will reach out to you in due course if we consider any amendments to your contracts referencing such rates to be appropriate or necessary.
6. Derivative products
6.1 How are Central CounterParties (CCPs) transitioning to Risk Free Rates (RFRs)?
LCH, Eurex and CME began using €STR to discount future cashflows and calculate interest payments on collateral, also known as Price Alignment Interest (PAI) as per 27 July 2020.
CME and LCH switched from the Effective Federal Funds Rate (EFFR) to SOFR on 16 October 2020. The same change has been applied to the PAI. To account for the economic impact, both CME and LCH have applied a combination of cash compensation and Fed Fund/SOFR Basis Swaps.
6.2 When are ISDA changes to fallbacks implemented?
On the 23rd of October 2020, ISDA published its updated IBOR Fallback Supplement to the 2006 ISDA Definitions. The effective date of this Fallback Supplement was the 25th of January 2021. As from this date, all new derivatives referencing the 2006 ISDA definitions include the fallbacks as included in the Fallback Supplement.
6.3 How does ISDA define a trigger event?
The ISDA provides new triggers and fallbacks with respect to a range of relevant IBORs. Fallbacks will be triggered upon a cessation event (i.e. when an IBOR is permanently discontinued) or in the case of a pre-cessation event (i.e. when the FCA announces the rate is, or the future date where it will no longer be, representative. This future date is referred to as the ‘Index Cessation Effective Date’).
7. Fallback provisions
7.1 What is a fallback provision?
A fallback provision in a legal contract determines what reference rate parties will use in the event that the initially agreed upon reference rate is not available. Without a fallback to another reference rate, parties to a contract which references a certain reference rate might find themselves in dispute over action taken in response to the unavailability of the designated reference rate.
7.2 Why are fallback rates important?
Fallback rates serve as insurance against the temporary or permanent cessation of a reference rate.
7.3 Is there standardized fallback language available?
The industry working groups and other authorities have developed guidelines to draft standardized fallback language which might be included in new products and that specifically addresses LIBOR cessation. There are two main approaches used to draft fallback language: the hardwired approach and the amendment approach. ‘Hardwiring’ fallback language is a way of drafting fallback language to have pre-agreed aspects regarding the replacement reference rate and the process of how and when the loan will transition to the replacement reference rate. This is in contrast to fallback language using the “amendment approach” which only specifies that parties need to agree a replacement rate when certain triggers in the documents have occured.
7.4 What are the key elements of a ‘hardwired’ fallback provision?
Trigger Event – the event giving rise to the application of the fallback provision, or the future date from which the fallback will apply Fallback Rate – the new reference rate which will apply in that event
Spread adjustment – if the new fallback rate differs from the original reference rate, then it may be necessary to include a spread adjustment to minimize any transfer of value from one party to the other.
8. Rabobank and the reference rate reform
8.1 Are these changes an initiative of Rabobank?
No, the changes are proposed by industry wide working groups on the recommendation of supervisors and central banks. More information and background can be found on the website of the Nederlandse Vereniging van Banken.
8.2 Are these changes only relevant for Rabobank products?
No, every contract that references an affected reference rate will be affected, whether this contract is entered into with Rabobank or another party.
9.1 Is the COVID-19 pandemic affecting the timelines of the transition?
Working groups have announced to continue focusing on the established timeline for the transition. They recognize that near-term, interim steps maybe delayed given the current economic environment with the global pandemic, but it remains clear that the financial system should continue to move to transition by the end of 2021 and presumably June 2023.
9.2 Where can I find more information on the benchmark transition?
Please refer to the following websites for more information on the benchmark transition:
- Nederlandse Vereniging van Banken
- Alternative Reference Rate Committee
- Working Group on Euro Risk-Free Rates
- Working Group on Sterling Risk-Free Rates
- International Swaps and Derivatives Association