The administrator of LIBOR has announced it will cease the publication of the one week and two month USD LIBOR settings immediately following the LIBOR publication on December 31, 2021, and the remaining USD LIBOR settings immediately following the LIBOR publication on June 30, 2023.
LIBOR served as a measure of interest rate banks were willing to pay one another, which became standard benchmark in derivatives markets. However, after 2008 financial crisis, the world started to recognize the risks associated with LIBOR and unsecured borrowing & lending transactions. Accordingly, unsecured borrowing inter-transactions within banks declined, which further posed a challenge with LIBOR as the size of the underlying market feeding into LIBOR submissions have been dropping.
As LIBOR becomes less robust, it inevitably will cease to exist. Then, the alternative is essential because without universal reference rate, there will be a significant financial instability in the market. With Financial Stability Board report in 2013 regarding risk to financial stability from LIBOR transition, a few economies developed unique reference rates:
| U.S. | U.K. | E.U. | Japan | Switzerland |
|---|---|---|---|---|
| SOFR (Secured Overnight Financing Rate) |
SONIA (Sterling Overnight Index Average) |
ESTR (Euro Short-term Rate) |
TONA (Tokyo Overnight Average Rate) |
SARON (Swizz Average Rate Overnight) |
| U.S. | SOFR (Secured Overnight Financing Rate) |
|---|---|
| U.K. | SONIA (Sterling Overnight Index Average) |
| E.U. | ESTR (Euro Short-term Rate) |
| JAPAN | TONA (Tokyo Overnight Average Rate) |
| Switzerland | SARON (Swizz Average Rate Overnight) |
Each reference rate is meant to reinforce weaknesses in LIBOR by being overnight rate and transaction based benchmark reference rate. With an overnight rate, the market requires modeling of the term structure with different maturities in order to reflect expectations about where interest rates will be in the future. Consequentially, a corporate taking a loan will be able to predict payment in three months’ time. With feature of wholly transaction-based rate, new interest rate benchmarks are more durable over time by reflecting the cost of secured financing across variety of market participants.
Of the possible candidates, USD-based financial markets is favoring Secured Overnight Financing Rate (SOFR), a new benchmark reference rate leading a transition from LIBOR and positioning the transformation of U.S. market.
In order to be prepared for the likely case of LIBOR discontinuation, KEB Hana Bank NY Agency seeks to adjust to robust reference rate with characteristics of measurable and reliable benchmark. We continue to build a structured response by appointing a designated team for LIBOR replacement task and coming up with a uniformed clause on Legal Documents accompanying Fallback Rate Adjustments. We will notify and update our customers in a timely manner so that our clients can better accommodate possible transformation in the reference rate.