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Since the beginning of this year, we are no longer transacting in USD LIBOR contracts, barring very limited exceptions, as discussed on our Information Hub.
There has already been a significant and smooth transition away from USD LIBOR for many markets. New activity in USD over-the-counter derivatives and capital markets products is predominantly linked to SOFR now. Additionally, the transition from USD LIBOR to SOFR appears to be progressing smoothly in lending markets. Use of SOFR continues to increase rapidly in exchange traded derivatives.
ARRs do not encompass a bank funding premium as LIBOR does. Therefore, they may react differently to changes in market conditions. This became clear, for example, at the start of the COVID pandemic in March 2020: LIBOR rates rose as demand for short-dated bank liabilities declined in the face of global uncertainty, while central bank policy rates were being reduced, prompting a sharp decline in ARRs.
In addition to SOFR-based rates, the USD market has witnessed the development of ‘credit sensitive rates’. These are rates that reflect borrowing costs of financial institutions, as LIBOR did. They are intended to be more robust than LIBOR was, as the rates’ inputs consist largely of traded data instead of bank panel submissions. However, supervisors have repeatedly expressed misgivings about these rates and as of now, Commbank does not make them available to its customers.
Forward looking ‘term rates’ are rates based on expectations of ARRs. They are not available in all currencies, and in the markets where they are available, their usage may be limited. For example, term SONIA is not recommended for use in the institutional loan market. In regards to Term SOFR, the New York Fed’s Alternative Reference Rates Committee (ARRC) published its ‘best practices’ for the usage of this rate.
Term SOFR is widely used in the US loan market. However, the use of Term SOFR in the derivatives market is much narrower, as its recommended usage is limited to hedging cash exposures incurred by end users. Given the absence of Term SOFR trading in the inter-dealer market you may find that execution costs of Term SOFR hedging are different from those of hedging a compounded SOFR exposure.
It is important to note that the liquidity of LIBOR-referencing products is expected to decline as the market gets closer to LIBOR’s discontinuance on 30 June 2023. Additionally, there will be a very large volume of contractual change that the market and your counter parties will be absorbing ahead of LIBOR’s discontinuance. We therefore recommend that you start transition discussions as soon as practical.
After 31 December 2021, LIBOR bank panel submissions were ceased and representative LIBOR rates have no longer been available. Sterling and Yen LIBOR is still being published in 1,3 and 6 month tenors. However, that published rate is not based on bank panel submissions. Rather, it is made up of the risk-free rates (SONIA and TONAR respectively) with some adjustment, intended to approximate what LIBOR might have been, if it had continued. Synthetic LIBOR cannot be used in new contracts. Synthetic Yen LIBOR will not be published after 31 Dec 2022. Synthetic Sterling LIBOR’s continuation beyond that date, in some or all of the three tenors, is unknown at this point but will be known later this calendar year.
Whilst LIBOR has a definitive end-date, not all interest rate benchmarks that reflect bank funding costs – “IBORs” – are expected to discontinue. IBORs that will remain for the foreseeable future include, for example, EURIBOR and Hong Kong’s HIBOR, as well as Australia’s local credit-benchmark BBSW, which remains robust. Given the global adoption of alternative risk-free reference rates (RFRs), we may witness increased usage of Australia’s ARR - the cash rate, also known as AONIA - in certain products, such as multi-currency lending facilities and cross-currency swaps. A similar adoption of ARRs may occur in other jurisdictions where a local IBOR is still available for use alongside an ARR.
Certain other IBOR’s do have an expected path to discontinuance, either because they use USD LIBOR as an input – such as the Singapore rate SOR – or because there are concerns about the future robustness of the rate – such as CDOR.
We encourage you to seek independent advice regarding any legal, commercial or regulatory implications that LIBOR cessation may have. Please also refer to your relevant authorities and independent advisors in relation to any accounting and tax implications of transition.
As nothing in this document should be taken to be advice, we encourage you to seek independent advice on these matters and you should reach your own conclusions and decisions, in consultation with your own advisors. The information in this document might change and we are not undertaking to update it.
This information is published solely for information purposes. It is not to be construed as a solicitation, an offer or recommendation by the Commonwealth Bank of Australia (CommBank). As this information has been prepared without considering your objectives, financial situation or needs, you should before acting on the information, consider its appropriateness to your circumstances. It must not be relied upon as investment research. CommBank believes that the information is correct and any opinions, conclusions or recommendations are reasonably held or made, based on the information available at the time of its compilation, but no representation or warranty, either expressed or implied, is made or provided as to accuracy, reliability or completeness of any statement made. Commonwealth Bank of Australia ABN 48 123 123 124. AFSL and Australian Credit Licence 234945.
