IBOR TRANSITION: REPLACEMENT OF REFERENCE RATES

Overview

IBORs (Interbank Offer Rates), such as EURIBOR or LIBOR, are reference rates that are used worldwide in contracts by banks, asset managers, insurers, but also by companies outside the financial sector as a risk-free interest rate.

Necessity for the replacement

IBORs are calculated on the basis of daily surveys of panel banks on unsecured interbank transactions. As the market for such interbank transactions has become much less liquid since the financial crisis and banks are increasingly reluctant to participate in the surveys, determining IBORs has become more difficult. In the past, this has already led to fewer maturities being published for EURIBOR since 2013.

In addition, it was revealed in 2011 that the most important IBORs, including LIBOR and EURIBOR, had been manipulated for years by some of the panel banks. Therefore, it was decided to reform or phase out the main IBORs.

Euro reference rates

The reference rates for transactions in euro are EUR LIBOR (with maturities from over-night to one year), EURIBOR (with maturities from one week to one year) and EONIA (over-night only).

In our experience, the use of EUR LIBOR is rather limited, while the use of EURIBOR is much more common. Whereas EUR LIBOR, as well as all other LIBORs, will be phased out by the end of 2021, EURIBOR has already been reformed and will therefore continue to be available in the usual form and for the existing maturities. EONIA, on the other hand, has already ceased to be calculated as of October 2019 and has been replaced by €STR. All EONIA values published since then correspond to the €STR plus a premium of 8.5 basis points set by the ECB.

For transfer pricing purposes, this means that there is essentially only an immediate need for action if the EUR LIBOR is used. Here, a switch to EURIBOR for the period after 2021 may be a feasible solution. Since EURIBOR will continue to exist and EONIA can still be derived from €STR even if it will no longer be published in the future, there is no immediate need for action if these reference rates are used.

USD reference rates

The reference rate for transactions in U.S. dollars has traditionally been USD LIBOR. This is published with maturities ranging from over-night to one year.

As mentioned above, all LIBOR reference rates (such as for GPB, CHF and JPY), therefore also the USD LIBOR will be phased out by the end of 2021. From this point on, panel banks will no longer be obliged to provide data for the calculation of LIBORs, which is why published values from this point on will probably be based on fewer and fewer actual transactions.

Therefore, there is an immediate need for action for USD transactions. The SOFR was created as a replacement for the USD LIBOR. However, this is not fully comparable with previous reference rates, as the SOFR, unlike the USD LIBOR (and also all other reference rates for the euro mentioned so far), is based on collateralized transactions between banks. Furthermore, the SOFR also confronts users with the problem that it is currently only available as an over-night interest rate. However, as a solution to this problem, interest rates with maturities of up to one year are calculated by financial service providers based on SOFR values.

The fact that SOFR is based on collateralized transactions compared to USD LIBOR should lead to a lower interest rate than USD LIBOR, which would probably mean lower interest rates at the expense of lenders. However, financial market data do not show a clear trend. In the past, SOFR has often been higher than USD LIBOR. In practice, this means that all parties involved in a transaction can probably emerge as winners or losers from the switch to the SOFR. However, this will probably be the case between third parties (e.g. in the case of bank loans) in a similar way.

Amendments of contracts

Whether the expiry of reference rates (such as LIBOR) requires an adjustment of intra-group contracts depends on the specific individual case. If provisions regulating the expiry of reference rates have already been made, no additional agreement may be necessary. If such clauses are not provided for in contracts, they could become part of the contract by means of additional agreements between the transaction partners. Consultation with a legal representative is recommended for this purpose.

Conclusion

For intra-group financial transactions in Euro, the impact of the IBOR transition is rather minor in most cases thanks to the reform of EURIBOR in 2019 and the fixed peg of EONIA to €STR. Only those financial transactions that are based on EUR LIBOR will have to be switched to other reference rates, such as EURIBOR.

In other currencies the IBOR transition is more relevant to financial transactions, especially to those in USD. If these continue beyond 2021, a transition to other reference rates might be unavoidable. If no contractual provisions have been made to date for the expiration of reference rates, additional agreements will probably be necessary.