The Financial Conduct Authority (FCA), formally announced on 5^th March 2021, that the following LIBOR benchmark rates will either cease to be provided or will no longer be representative immediately after the following cessation dates :

• 31^st December 2021: All LIBOR benchmark rates in respect of Sterling, Euro, Swiss Franc and Japanese yen as well as the US Dollar (only 1-week and 2-month) LIBOR benchmark rates
• 30^th June 2023: Overnight, 1-month, 3-month, 6-month, 12-month USD LIBOR benchmark rates

No action is required for contracts maturing before the cessation date of the referenced LIBOR benchmark rate while for all contracts maturing after the cessation date of the referenced LIBOR benchmark rate, the reference rates in the contracts need to be amended from current LIBOR to alternate reference rates. Moreover, regulators/working groups have issued guidance with regards to ceasing the issuance of new LIBOR products (see [3], [4], [5], [6], [7], [8] for more details) and the ARR working groups have recommended that any new floating rate financing arrangements should be based on RFRs and not on LIBOR. Customers are encouraged not to enter into new financial contracts that reference LIBOR as a benchmark.

LIBOR is a forward-looking rate known at or prior to the commencement of the period to which they relate, ARRs are backward-looking overnight rates. LIBOR includes a built-in risk premium for AA Bank credit risk and tenor liquidity premium, however ARRs are considered to be nearly risk-free rates. Since ARRs are O/N rate, they don’t have any tenor liquidity premium[1]. Some of the ARRs are unsecured and contain credit risk component, however it is smaller as compared to LIBOR. Also, ARRs are calculated on a structurally different basis than LIBOR and are not a like-for-like replacement for the same.

The table below sets out a non-exhaustive list of the differences between LIBOR and RFR.

¹https://www.bankofengland.co.uk/-/media/boe/files/markets/benchmarks/rfr/what-is-sonia-supporting-slides.pdf

Various risk-free or near risk-free rates as alternative to LIBOR have been identified by various authorities and industries working committees and are determining how existing benchmarks might be reformed in accordance with applicable regulation.

The table below lays out the alternative risk-free rates recommended and endorsed by various industry working committees:

A number of working groups have indicated a desire to develop similar forward-looking term structure for ARRs derived from O/N ARRs as LIBOR in several tenors. This helps in continuity in market standards. Due to certain limitations, these rates may not be suitable in certain markets and there is no broader market consensus on the way forward. The following points state the stance of different working groups on term rates derived from risk-free rates:

• UK’s Financial Conduct Authority selected ICE Benchmark Administration (IBA) to publish Term SOFR rates. IBA launched its ICE Term SONIA Reference Rates (“ICE TSRR”) on 11 January 2021 for use as a benchmark in financial instruments by licensees .
• The Alternative Reference Rates Committee (the “ARRC”) in US formally recommended CME Group’s forward looking SOFR Term rates on 29^th July 2021.
• The National Working Group on Swiss Franc Reference Rates does not recommend the use of a forward-looking term rates derived from risk-free rates.

Compounding in arrears would compound daily values of the overnight rate throughout the relevant term period. This would mean that the applicable interest rate would only be known at the end of the interest accrual period. However, there are conventions in place such as arrears with payment delay, arrears with n-day lockout and arrears with n-day lookback which reduce the uncertainty of the final interest rate payable by the borrower.

The ARRC’s User’s Guide to SOFR provides a comprehensive overview of the different compounding conventions that can be used with SOFR . The RFR Working Group published recommendations regarding conventions for referencing SONIA compounded in arrears in the sterling loan market in September 2020 which contains illustrative worked examples of index compounding conventions for the Sterling loan market . Compounding in arrears is compatible with a wide variety of derivatives and cash products.

 LIBOR will be used to calculate the interest rate until it stops being published. The interest rate for subsequent periods would no longer be calculated based on the relevant LIBOR rate. For subsequent periods, the interest rate would be calculated as per the fallback language in the contract.

Fallback language refers to the contractual provisions that lay out the process through which a replacement rate can be identified if a benchmark (e.g., USD LIBOR) is not available. This will also include an adjustment spread to deal with the differences between LIBOR and chosen fallback rate (Refer to section 4 for more details). Language also varies between derivatives and cash products and, even further, between different cash products The Industry bodies are also working to develop robust fallback provisions for several other interbank offered rates (IBOR) referencing transactions.

The International Swaps and Derivatives Association (ISDA) amended the ISDA 2006 Definitions to include LIBOR fallback protocol for OTC derivatives. Moreover, on 11^th June 2021, ISDA published the 2021 ISDA Interest Rate Derivatives Definitions, the latest in a series of definitional booklets that have provided the framework for documenting over-the-counter interest rate derivatives transactions since 1985. For cash products, national working groups, such as the US ARRC, have published proposed fallback language to implement in new transactions referencing IBOR. Refer to the next question for further details. 

The Alternative Reference Rates Committee has published recommended fallback language for:

• Floating Rate Notes
• Bilateral and Syndicated Business Loans
• Securitizations
• Student Loans 
• Adjustable Rate Mortgages . 

Fallback language has further been made available by other industry bodies, including the International Swaps and Derivatives Association (ISDA) (which include fallback language for IBOR-referencing derivatives as part of the amendments to the ISDA 2006 Definitions and a Protocol to facilitate the amendment of legacy derivatives transactions to include such fallbacks  language) and the Loan Market Association (LMA).  

On 23^rd October 2020, ISDA published its IBOR Fallbacks Protocol (Protocol) and Supplement to the 2006 ISDA Definitions (Supplement) to address the expected cessation of LIBOR and IBORs at the end of 2021. The rate option definitions do contain fallback provisions, but they were only intended to address short-term disruptions to the publication of LIBOR and other IBORs. With the permanent end of IBORs in sight, these current fallback provisions would appear to be inadequate to ensure a smooth transition to alternative benchmark rates.

The Protocol allows parties for derivatives transactions to bilaterally amend their existing transactions to incorporate the terms and conditions that are contained in the Supplement.

LIBOR and ARRs are structurally different. The difference was explained in the first question within the risk-free rates section above. As specified, ARRs are O/N rate, they don’t have any tenor liquidity premium. Some of the ARRs are unsecured and contain credit risk component, however it is smaller as compared to LIBOR. Thus, direct replacement of LIBOR with risk-free rates will cause a transfer of value from one party to another. In order to make the rates more comparable and in line with each other, a credit adjustment spread (CAS) is added to the risk-free rate.

LIBOR+Margin  -->  RFR+CAS+Margin                           

The credit adjustment spread calculated as per the ISDA methodology uses the historical median approach. Under this method, the credit adjustment spread is calculated as the median difference over a historic five-year period between the relevant LIBOR being replaced and the corresponding risk-free rate compounded in arrears for the term equivalent to the term of the LIBOR it replaces  (aka “ISDA Median Spread”).

ISDA on March 5, 2021, confirmed following FCA’s announcement in relation to the permanent cessation and non-representativeness of all LIBOR settings. The “Spread Adjustment Fixing  Date” had occurred and, accordingly, the credit spread adjustment had been fixed for all 35 LIBOR  settings under the Bloomberg IBOR Fallback Rate Adjustments Rulebook . On such date, Bloomberg published the fixed spread adjustment as calculated in respect of each LIBOR tenor.  

The fixed spread adjustment as recommended by ISDA and published by Bloomberg shall be calculated from 5^th March 2021. This fixed credit adjustment spread will apply to all contracts that reference the ISDA master agreement and the revised 2006 ISDA definitions. These spreads are available in. 

Basis risk can arise if there is a difference between the credit spread adjustment calculation methodology between derivatives and cash products. Industry working groups have been strongly advocating consistency across derivatives and cash products. the basis risk between derivatives and cash products should be low.

IDFC FIRST Bank is working with clients to transition legacy LIBOR-impacted contracts before the given LIBOR ceases to be published.  There are various industry standards that facilitate and accelerate the transition. IDFC FIRST Bank will try to follow these industry standards consistently wherever it deems to be practical. However, the Bank also encourages clients to take appropriate independent professional advice (legal, tax, accounting, financial or other) in order to comprehend the impact of discontinuation of any LIBOR.  

The Bank could have multiple implications contingent on various items such as the contractual provisions for the financial product, the alternative ARR solutions available, etc. So, IDFC FIRST Bank encourages clients to take appropriate independent professional advice (legal, tax, accounting, financial or other). Furthermore, clients may (on advice) of their financial/legal consultants decide on whether to adhere to ISDA IBOR Protocol and if not, then agree to such Protocol bilaterally by amendment to the ISDA and impacted contracts with the bank.

IDFC First Bank encourages clients to be up to date with the latest industry developments with respect to LIBOR transition. The Bank also recommends that clients monitor the latest announcements by working groups, trade associations and international bodies. The websites of the working groups for each currency, FCA and ISDA are good sources of information to stay updated with the latest developments on LIBOR transition. Alternatively, the bank also suggests clients to stay in touch with their own legal and financial advisers to familiarise with ARRs and seeking clarification with regards to any issues/queries.

The Bank has adhered to the standardized ISDA 2020 IBOR Fallbacks Protocol, to establish a legal basis for continuation of IBOR-based trades between adhering parties even when IBORs are rendered ineligible as acceptable benchmarks effective from IBORs cessation date(s). ISDA Amendment Agreement is being prepared for recording clauses pertaining to LIBOR Transition which will be signed by counterparties who have not adhered to ISDA Standard Fallback protocol. There will be differences in client cash flows due to differences in the method of calculating interest on account of transition.

FCA, Bank of England and members of the Working Group on Sterling Risk-Free Reference Rates jointly announced that despite the COVID-19 pandemic, firms cannot rely on LIBOR being published after the end of 2021 and that this should remain the target date for all firms to meet. However, there could be a delay in achieving pre-set milestones.

New deals done in above products would be guided accordingly. For queries regarding any product not covered above, contact your treasury relationship manager or email us at: cts@idfcbank.com

For queries regarding this topic, contact your treasury relationship manager or email us at: cts@idfcbank.com

The Mumbai Interbank Forward Offer Rate (MIFOR) is the rate that Indian banks use as a benchmark for setting prices on forward-rate agreements and derivatives. It is a mix of the London Interbank Offered Rate (LIBOR) and a forward premium derived from Indian forex markets. It is published for O/N, 1, 2, 3, 6 and 12-months maturities at 5 PM IST every day and is used for interbank transactions only. In India, exposures to LIBOR arise from loan contracts linked to LIBOR, foreign currency non-resident (FCNR) deposits with floating rates of interest linked to LIBOR, and derivatives linked to LIBOR or MIFOR.

MIFOR will be replaced by Adjusted MIFOR and Modified MIFOR. While Adjusted MIFOR for legacy contracts is proposed to be computed as basis adjusted SOFR and USD INR forward premia as its components,  Modified MIFOR for new MIFOR contracts will be computed using the Adjusted SOFR (SOFR compounded in arrears) rate and the FBIL Forward Premia rate.

Contracts referencing LIBOR / MIFOR may generally be undertaken after December 31, 2021 only for the purpose of managing risks arising out of LIBOR / MIFOR referenced contracts undertaken on or before December 31, 2021.

RBI has advised Banks to cease using the Mumbai Interbank Forward Outright Rate (MIFOR), a benchmark which references the LIBOR, as soon as practicable and in any event by December 31, 2021.

Financial Benchmarks India Pvt Ltd (FBIL) has started publishing daily adjusted MIFOR rates from June 15, 2021 and modified MIFOR rates from June 30, 2021 which are used for legacy contracts and fresh contracts respectively.

Based on clarifications from Bloomberg, the overnight rate would be provided. In case it is not available, post- LIBOR cessation, the SOFR from FED would be taken and the constant spread of O/N SOFR to O/N LIBOR based on 5-year data would be applied.  

Steps suggested by RBI to ensure preparedness of banks to transition away from LIBOR :

The transition away from LIBOR and the adoption of RFRs developed in various jurisdictions is a significant event which needs to be carefully prepared for in order to manage potential customer protection, reputational and litigation risks as well as to avoid disruptions to the safety and resilience of financial institutions and overall financial stability of the economy. For the same, RBI issued guidelines to assist banks and other RBI regulated entities to transition from LIBOR to RFRs. The steps suggested are as follows:Banks and financial institutions are encouraged to cease entering into new financial contracts that reference LIBOR as a benchmark and instead use any widely accepted alternative reference rate (ARR), as soon as practicable and in any case by 31^st December 2021.

• Banks and financial institutions are urged to incorporate robust fallback clauses in all financial contracts that reference LIBOR and the maturity of which is after the announced cessation date of the LIBOR settings.
• Banks and financial institutions are encouraged to ensure that new contracts entered into before 31^st December 2021 that reference LIBOR and the maturity of which is after the date on which LIBOR ceases or becomes non-representative include fallback clauses.
• Banks have also been advised to cease using the Mumbai Interbank Forward Outright Rate (MIFOR), a benchmark which references the LIBOR, as soon as practicable and in any event by 31^st December 2021. In this context, Financial Benchmarks India Pvt Ltd (FBIL) has started publishing daily adjusted MIFOR rates from 15^th June 2021 and modified MIFOR rates from June 30, 2021 which can be used for legacy contracts and fresh contracts respectively.
• Contracts referencing LIBOR / MIFOR may generally be undertaken after 31^st December 2021 only for the purpose of managing risks arising out of LIBOR / MIFOR referenced contracts undertaken on or before 31^st December 2021.

RBI Advisory: Key issues identified with benchmarks replacing MIFOR

Banks have been advised to cease using the Mumbai Interbank Forward Outright Rate (MIFOR), a benchmark which references the LIBOR, as soon as practicable and in any event by 31^st December 2021. In this context, Financial Benchmarks India Pvt Ltd (FBIL) has started publishing daily adjusted MIFOR rates from 15^th June 2021 and modified MIFOR rates from 30^th June 2021 which can be used for legacy contracts and fresh contracts respectively. Other alternatives are MROR, MIBOR, use of SOFR with USD INR Cash/Tom Swap rate, etc. It was noted that each of the alternate benchmarks shall have advantages and issues.The use of the SOFR with the forward premia, for example, shall closely mimic the MIFOR but shall involve the use of one forward-looking and one backward-looking component.

• Use of the SOFR and the USD INR Cash/Tom Swap Rate, both of which are compounded in arrears, will address this issue but a benchmark based on cash / tom swap rates is likely to be more volatile than one based on forward premia.
• The MROR is a benchmark based on secured overnight transactions in a liquid market encompassing both bank and non-bank participants and hence closely shares the features of international RFRs. At present, however, IRS contracts referencing the MROR are not prevalent.
• The MIBOR is based on a less liquid interbank call market but MIBOR-based swaps account for the bulk of outstanding IRS contracts in the country. In any case, MIBOR, MROR and T-bill rates are domestic rates and their use as a RFR will need the development of a market for cross currency basis swaps. Issues associated with deriving a term structure for the RFR, as in global markets, will also need to be addressed.

Contracts referencing LIBOR / MIFOR may generally be undertaken after 31^st December 2021 only for the purpose of managing risks arising out of LIBOR / MIFOR referenced contracts undertaken on or before 31^st December 2021.

Market participants holding instruments referencing LIBOR could experience ambiguity with regards to the rate replacing LIBOR post cessation. It is important that market participants comprehend the risks associated with holding existing as well as new instruments with LIBOR references.

Some of the risks faced are mentioned below:

• Valuation Risk: Risk of changes in valuation of contracts referencing LIBOR either due to reduced submissions, discontinuation or amendments to the methodology used to calculate the benchmarks. This is true particularly if reference rates or fallback provisions are not aligned between commercially linked positions.
• Hedging Risk: Risk that effectiveness of hedging is undermined as benchmarks may perform differently than in the past, and financial products referencing existing Benchmarks scheduled to be discontinued may perform differently as a result.
• Contract Remediation Risk: Risk of inadequate amendments to contracts. Market participants are making changes to the contracts as per industry standards and in line with various guidelines, there exists a risk of inadequate coverage.
• Operational Risk: Operational and system changes required in the event of Benchmark cessation; in order to support new RFRs. For e.g. where systems need to be updated to support alternative rates.
• Tax and Accounting Risk: Tax and accounting impacts of amendments to existing financial arrangements.

Clients should independently assess the impact of these changes on their portfolio and take appropriate action as required.