Is December 31, 2021 still the target date for LIBOR cessation?

The short answer to the above question is yes. The Financial Conduct Authority issued a statement March 25, 2020, stating that the Financial Conduct Authority, the Bank of England and the Sterling Working Group continue to believe that LIBOR transition will strengthen the markets and the market should not count on LIBOR being published after December 31, 2021 despite the impact of the coronavirus pandemic.

While some of the interim deadlines may be changing, the date set for cessation of LIBOR being published has not been extended. As financial entities grapple with the impacts to infrastructure, the markets and the dislocation of staff, work on LIBOR transition efforts have to continue.

FHFA moves interim target dates for cessation

In March 2020, the FHFA extended the date for FHLBs to cease utilizing LIBOR in derivatives, Advances and Debt that mature after December 31, 2021 from March 31, 2020 to June 30, 2020. The deadline for collection of LIBOR collateral information and reporting to FHFA has been extended to September 30, 2020.

ARRC announces key objectives for 2020

The Alternative Reference Rate Committee (ARRC) recently announced their key objectives for 2020.

These 2020 objectives center on the following core tenets of the ARRC’s work:

  1. Supporting SOFR use and liquidity.
  2. Encouraging the development and strengthening of market infrastructure and operations to support SOFR.
  3. Creating and encouraging the use of robust contractual fallbacks.
  4. Developing materials to support consumer education and outreach efforts.
  5. Increasing clarity on key legal, tax, accounting, and regulatory matters.
  6. Advancing outreach, education, and global coordination.

The ARRC also included a link to a webinar in their announcements.

Proposed New York legislation

The ARRC recently proposed legislation to be presented to the New York state legislature with the intent on remedying those LIBOR-based loans that do not have fallback language or have fallback language that is not workable in the current market environment (see links). The New York legislature is currently engaged in issues related to the pandemic. Until the legislature can refocus, the supporters of the legislation have signed a letter signifying this support. The FHLB System signed this letter, represented by FHLB New York.

The ARRC also posted a webinar to review the proposal (registration required).

Development efforts for a 'supplemental dynamic credit spread'

In the spirit of continuing LIBOR transition and in regards to how SOFR behaves in stressed markets, a new Credit Sensitivity Group has been created by members of the US Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and select US regional banks and community banks. The first meeting of this group took place in February.

The group was formed to discuss the challenges faced by U.S. regional banks and community banks in incorporating SOFR in loan agreements. As SOFR is a secured risk-free rate that is meant to be closer to how large banks are funding themselves (with access to government funding programs), in a stressed environment, the SOFR rate falls as the market turns to risk-free instruments. Regional and community banks are concerned that when markets are stressed there should be a credit component to represent the increased counterparty credit risk in the market. The committee is tasked with formulating a methodology for a supplemental dynamic credit spread that meets standards for transparency and robustness.

In summary, SOFR is still the chosen replacement rate in the U.S. The target date for ceasing to publish LIBOR is December 31, 2021. All financial entities should continue their LIBOR transition efforts.

FHFA moves interim target dates for cessation

In March 2020, the FHFA extended the date for FHLBs to cease utilizing LIBOR in derivatives, Advances and Debt that mature after December 31, 2021 from March 31, 2020 to June 30, 2020. The deadline for collection of LIBOR collateral information and reporting to FHFA has been extended to September 30, 2020.

Change in discounting methodology at the clearing houses

The swap Central Counterparty Clearing (CCP) houses or Derivatives Clearing Organizations (DCOs) will be moving away from discounting utilizing the Effective Fed Funds rate to utilizing the Secured Overnight Financing Rate (SOFR) to value future cashflows and interest paid on collateral (PAI) for cleared swap trades. This will happen in mid-October 2020. 

What does this mean for the market and for you? The futures markets and swap markets for longer dated SOFR based swaps may become more liquid as Dealers will need to hedge themselves further out the curve. The value of existing cleared swaps will change and you need to be aware that you will be compensated for the change differently at CME and LCH. CME plans to utilize basis swaps to compensate for the valuation difference and LCH is planning to use cash payments to settle the differences.

Results of ISDA consultations

ISDA has conducted a series of consultations (request for opinions from the financial community) regarding LIBOR fallback language. ISDA plans to have a protocol available by the end of the first quarter of 2020 which will modify the ISDA 2006 definitions for interest rate swaps to include fallback language in case of a LIBOR cessation.

The consultation results in regards to pre-cessation trigger language did not provide a clear financial industry preference for a pre-cessation trigger and thus ISDA does not plan to include this language in the protocol. ISDA received a letter from the Financial Stability Board strongly urging them to reconsider. ISDA responded by stating that there will be a follow-up consultation regarding pre-cessation triggers and if there is a response to the consultation that this is desired, another protocol will be issued. The protocols will only cover bilateral non-cleared trades. ISDA has also said that some non-ISDA documents could be included such as Master Repurchase Agreements.

Federal Reserve consultation

The Federal Reserve has recently conducted their own consultation regarding the publishing of SOFR and backward looking SOFR averages. While the results have not yet been published, the consultation indicated the Fed’s willingness to publish backward looking compounded SOFR averages for 30-, 90- and 180-days on their website. By publishing these tenors, it is hoped that users of these rates would be able to more easily calculate interest rates for these periods and possibly it would be easier for older loan systems to accept a single rate than calculate the rate. This could hasten the acceptance of SOFR that is being slowed by the amount of work needed to allow systems to accept SOFR in their interest calculations.

Financial Accounting Standards Board accounting relief

The Financial Accounting Standards Board (FASB) has ruled that the modification of existing hedging relationships, and of debt and other financial instruments due to reference rate reform will not constitute a new contract but rather the continuation of the existing contract or relationship. FASB has stated that “the proposal would provide optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met.” Please speak with your auditors to understand how this will specifically apply to your own transactions.

Note: FHLB Cincinnati continues to respond to various industry consultations either individually or through System responses.  We strongly urge the membership to participate in the process and have your opinions on these issues be heard.