The Financial Conduct Authority (FCA), the U.K. regulator which oversees the LIBOR rate, announced in 2017 that it would not compel banks to submit rates required to calculate LIBOR after the end of 2021. On November 30, 2020, the ICE Benchmark Administration (IBA), with the support of the FCA, the Federal Reserve Board and the Alternative Reference Rates Committee (ARRC), announced that it will undertake a market consultation on its intention to cease publication of the one-week and two-month U.S. dollar LIBOR tenors on December 31, 2021, and the remaining U.S. dollar LIBOR tenors on June 30, 2023. Therefore, while a significant benchmark rate for over 30 years, the future of LIBOR is limited. The FCA, U.S. regulators and other regulators globally have actively encouraged market participants to take steps to stop using LIBOR and to replace LIBOR with a stronger, more reliable benchmark.

In light of this, it is important that our customers understand what the transition entails and the actions they should consider taking to prepare their businesses. Santander will also be contacting customers to outline our intended approach.

Due to changing industry norms, the number of actual transactions upon which LIBOR is based has decreased significantly. The underlying market that LIBOR is derived from is no longer used in any significant volume and the ongoing slowdown in unsecured bank debt market activity has further diluted LIBOR’s relevance. Therefore, the submissions made by banks to sustain the LIBOR rate are often based (at least in part) on expert judgement rather than actual transactions.

The FCA has concluded that the way in which LIBOR is calculated in practice means that it no longer complies with internationally accepted principles for robust interest rate benchmarks. As such, in 2017, the FCA announced its intention to stop compelling banks to submit the rates required to calculate LIBOR after the end of 2021, and has announced its support of the IBA’s recently announced market consultation regarding the extension of US dollar LIBOR tenors through June 30, 2023 (with the exception of the little used one-week and two-month tenors, which are still proposed to cease publication on December 31, 2021).

The London Interbank Offered Rate (LIBOR) is used in the calculation of interest and other payments under many financial contracts, including loans, derivatives, bonds and agreements for other financial transactions, both in the U.S. and abroad.

LIBOR is a set of benchmark interest rates that provide an indication of the average rates at which panel banks could borrow wholesale, unsecured funds from each other for set periods in particular currencies. It is calculated and published daily by the IBA based on submissions from a panel of banks. It is published across a range of currencies (USD, GBP, EUR, JPY and CHF) and maturities (overnight, one week, one month, two months, three months, six months and one year). Globally, LIBOR has been used for decades as the primary benchmark rate for these short-term rates.

Approximately $200 trillion in outstanding financial contracts were tied to LIBOR globally as of March 2020.

Loans
As a general rule, loan documentation typically provides that if LIBOR is no longer available, the interest rate for a credit facility will be determined utilizing a prime-based rate. For loans originated or amended recently, as an alternative to the using the Prime Rate as the reference index if LIBOR is no longer available, loan documentation may also include a detailed “fallback” mechanism that allows the loan documents to be amended to incorporate a new reference rate to replace LIBOR, as well as spread and other adjustments to account for dierences between LIBOR and the new reference rate. In selecting the new reference rate and any adjustments, due consideration is expected to be given to recommendations made by the Federal Reserve Board or other applicable governing bodies, and/or to evolving or then prevailing market conventions for determining a replacement rate.

The Alternative Reference Rates Committee (ARRC), a financial industry group including a mix of banks, accounting firms, law firms and other industry stakeholders, was convened by the Federal Reserve Board and the New York Fed specifically to help facilitate the U.S. transition away from LIBOR. To aid in that transition, the ARRC has recommended using the Secured Overnight Financing Rate (SOFR) to replace LIBOR and has suggested standardized forms of fallback language for use in loan documentation applicable to cash products such as loans and mortgages. Unless the documentation for an existing loan includes a prime rate-based option in addition to a LIBOR-based rate component and the borrower is comfortable utilizing that prime-based rate when LIBOR permanently ceases to be available, it is likely that loan documents will need to be amended to incorporate LIBOR “fallback” language, whether in the form suggested by the ARRC or otherwise, to replace LIBOR and related terms and conventions with terms and conventions related to an alternative interest rate, such as SOFR.
 

Derivatives:
The International Swaps and Derivatives Association (ISDA), the leading industry group for the derivatives market, has recently announced publication of documentation and an ISDA protocol to address the transition away from LIBOR in derivatives transactions, both of which become effective on January 25, 2021. All new derivatives contracts entered into on or after this date will apply the new fallback language for replacing LIBOR irrespective of protocol adherence, and all then-existing contracts (“legacy derivatives contracts”) will incorporate such new fallback language if both counterparties have adhered to the protocol. Similar to the ARRC, ISDA also recommends using SOFR to replace LIBOR for swaps, and ISDA’s recommended LIBOR replacement terms are intended to align with the ARRC’s.

Alternatively, for legacy derivatives contracts parties may bilaterally agree to equivalent or dierent fallback terms to reflect an agreed replacement rate.

 

There are some important differences that may have an impact on the terms of your transactions and products with Santander.

For example, LIBOR is a forward-looking term rate, which means that the LIBOR rate for an interest period or calculation period is set at the start of that period, with payment due at the end. As such, this provides certainty of funding costs to assist cash flow management. Also, LIBOR embeds a credit premium (it implies bank credit risk) and a liquidity premium (it includes a premium for longer dated funds).

In contrast, the nominated alternative interest rate benchmarks are mostly backward-looking overnight rates. They are designed to be near risk-free and with no premium for term.

These differences have implications for how interest and other payments based on alternative interest rate benchmarks may be calculated relative to LIBOR-based transactions and products.

The transition of existing LIBOR-based contracts to contracts referencing alternative interest rate benchmarks may involve the payment of a spread adjustment and may impact the operation of certain financial covenants. There may also be cash flow and hedge accounting impacts if a mismatch arises on transition between a loan and a related derivative.

No. Similar initiatives are underway globally, including in the Euro Area, Switzerland and Japan where alternative interest rate benchmarks have also been nominated:

Currency

Reference rate

Proposed alternative rate

Features

Forum

USD

USD LIBOR*

SOFR (Secured Overnight Financing Rate)

Secured, overnight

The Alternative Reference Rates Committee

EUR

EUR LIBOR Eonia

€STR (Euro ShortTerm Rate)**

Unsecured, overnight

Working group on euro risk-free rates

CHF

CHF LIBOR

SARON (Swiss Average Rate Overnight)

Secured, overnight

The National Working Group on Swiss Franc Reference Rates

JPY

JPY LIBOR TIBOR

TONAR (Tokyo Overnight Average Rate)

Unsecured, overnight

Study Group on Risk-Free Reference Rates

Authorities and industry groups are working through the implications and the issues generated by the transition from LIBOR to the alternative interest rate benchmarks. This includes work on the market conventions for interest provisions based on alternative interest rate benchmarks (and the transition of LIBOR interest terms to them) and the potential development of forward-looking term rates for the alternative interest rate benchmarks.

However, the pace of the transition is not currently uniform or coordinated across each alternative interest rate benchmark and products. It is also not clear at this stage when new market conventions will emerge or if they will be consistent across products or currencies. In particular, it is not clear if or when forward-looking term rates for various alternative interest rate benchmarks will be developed.

The transition to alternative interest rate benchmarks will impact a range of transactions and products. You should expect to be affected if you have a floating rate loan or credit facility, deposit or derivative with Santander that has or may have payments linked to LIBOR or other affected legacy benchmarks that mature after the applicable LIBOR cessation date and your documentation does not already include fallback language.

There are several differences between LIBOR and the proposed alternative interest rates and, as a result, the transition may have pricing, cashflow, accounting and operational implications for you and your business. As mentioned above, authorities and industry groups continue to analyze the implications and issues generated by the transition, including how best to transition new and existing products and transactions to the alternative interest rate benchmarks across the range of products in a timely manner.

Santander continues to monitor these developments and evolve our transition plans as required.

Santander is working to keep affected customers and their businesses informed though this transition. We will contact you in due course with details on our proposed approach to the use of the alternative interest rate benchmarks, including when Santander will cease to offer legacy benchmark based products and how we would propose to deal with existing legacy benchmark based transactions or products (including the changes we may seek to make to their terms). We are committed to supporting our clients in their transition from LIBOR to alternative rates, and welcome the opportunity to discuss plans with you.

There are a number of steps that you may wish to take now:

  • ensure you are well aware of the background driving the LIBOR transition and review information available on LIBOR and other legacy benchmarks (including through the selection of links we have provided below);
  • undertake a review of any transactions you have that are based on LIBOR and other legacy benchmarks; 
  • consider if you have derivatives contracts that are linked to other transactions, such as loan linked swaps, and assess whether to transition the loan and swap to alternative rates at the same time or how to otherwise add consistent fallback language across contracts to promote alignment;
  • consider the potential impacts that the discontinuation of LIBOR and other legacy benchmarks may have on your business;
  • consider the potential impacts that the transition to alternative interest rate benchmarks may have on your business; and
  • seek advice from your financial and/or legal advisers.

If you would like to discuss this matter further with Santander, please contact your Santander relationship manager.

The websites of trade bodies contain additional information, including:

  • Alternative Reference Rates Committee (ARRC)
  • International Swaps and Derivatives Association (ISDA)
  • Loan Markets Association (LMA)