Libor transition – What to Expect from Regulators in the EU

Preparing for the definitive end of Libor has been on the mind of policymakers and industry alike for years and we are now entering the final stretch leading up to the definitive cessation of Libor on 31 December 2021 for most currencies in most tenors.

Across the industry, stakeholders are increasingly preparing for this, not only in terms of dealing with the past – transitioning their vast portfolios of Libor referencing contracts – but also in terms of dealing with the future and adjusting to the new risk-free-rates that are being phased in across all major jurisdictions as replacements for Libor.

IBA, the administrator of Libor, is currently consulting on ceasing Libor in all currencies and tenors – with the exception of the USD LIBOR - Overnight and 1, 3, 6 and 12 months – on 31 December 2021. For the subset of USD Libor tenors, the envisaged end-date is 30 June 2023. It is however likely that regulators will impose restrictions on use of these USD Libor tenors past 31 December 2021, allowing them to only exist for the purposes of letting existing exposures mature.

Beyond this and to facilitate dealing with the past, the International Swaps and Derivatives Association (ISDA) has announced the launch of its long-awaited derivatives fallback protocol, which will enter into force on 25 January 2021.

At the same time, there has been a growing realisation amongst EU policymakers that there is a distinct possibility that not all outstanding Libor referencing non-derivative contracts – especially those of corporates – will be renegotiated or amended with robust fallback language before Libor’s definitive cessation.

To that end, EU policymakers – the diplomatic representatives of Member States in Brussels as well as Members of the European Parliament have agreed a fast-tracked amendment to the EU Benchmarks Regulation to create a mechanism by which the European Commission (EC) can designate statutory fallback rates for Libor. This new framework would allow the EC to use its designation powers once several pre-determined pre-cessation triggers have occurred – e.g. the UK FCA formally announcing that Libor is no longer representative of the underlying market it is intended to measure.

This statutory fallback mechanism would enable the EC – in consultation with the industry – to designate the Libor replacement rates that have may have been developed by the major risk-free-rate working groups (e.g. in the United States, in the UK, in the EU, and potentially Switzerland) as the definitive replacement rates for Libor in contracts that are governed by EU law. Through this mechanism, the EC would designate a so-called complete rate package consisting of the replacement rates, the spread adjustment to Libor, and the recommended conforming changes that need to be made to contracts as per the recommendations of the relevant risk-free-rate working groups.

The statutory fallback – on the day of its entry into force – would then by virtue of the law replace all references to Libor in contracts that are still outstanding on that date and that have not been privately renegotiated. This mechanism is therefore intended as the ultimate fail safe and will be available for all contracts on a voluntary basis. Counterparties are left the choice of privately renegotiating their contracts in any case before the entry into force of the statutory fallback. However, for contracts that have not been renegotiated or where there is disagreement between the parties involved, the statutory fallback rate creates a safety net that would ultimately avoid contract frustration.

EACT will actively engage with policymakers throughout the process to ensure that the operationalisation of this fallback mechanism adequately reflects the needs of both financial and non-financial firms.

Tarek Tranberg
Head of Public Affairs & Policy
European Association of Corporate Treasurers