It is possible to identify three most important reasons for this reform. Firstly, it is impossible to solve the issue of manipulating the values of interbank rates by LIBOR participating banks. Secondly, it is a high degree of LIBOR dependence on expert judgments, rather than on actual transactions (according to the US Federal Reserve, the daily volume of three-month borrowings is USD 500 mln). Finally, the third reason is the impact of LIBOR on financial stability.
The LIBOR alternative was selected by five advisory councils for the five largest world currencies: US dollar, Euro, Yen, Swiss Franc and British Pound.
In 2017 in the US, the Alternative Reference Rates Committee selected SOFR a rate, which will replace USD LIBOR and will be used in all contracts. At the moment, the Committee is developing an action plan for the transition from USD LIBOR to SOFR.
In 2017 in the UK, the Working Group on Sterling Risk Free Reference Rates recommended to use the rate SONIA as a replacement for GBP LIBOR. In 2018, reforms of SONIA were carried out for a more correct and complete calculation and compliance with the best practices of IOSCO.
In 2017 in Switzerland, the National Working Group on Swiss Franc Reference Rates recommended the SARON rate as an alternative to CHF LIBOR. Starting from June 13, 2019, the National Bank focuses only on the new benchmark SARON and sets the boundaries of its fluctuations. Switzerland became the first country where the regulatory authority began to use the new risk-free rate as a tool of its monetary policy.
In 2016, the Working Group on Risk Free Reference Rates of Japan decided that TONA would replace JPY LIBOR, JPY TIBOR, EUROYEN TIBOR.
More recently than in other countries, work has begun to identify and replace risk rates in euros. In 2018, the Working Group on Euro Risk-Free Rate developed the new benchmark called ESTR (€STR) as a new money market rate that will be an alternative to the three rates: EUR LIBOR, EURIBOR, EONIA.
It is impossible to waive LIBOR without creation of the fixed-period instruments, where the underlying asset is a risk-free rate. In this regard, the financial industry is actively developing new instruments and bringing them to the markets. In December 2017, the ICE launched SONIA futures, and in October 2018 – SOFR futures. In May 2018, the SOFR futures were listed on the CME exchange. In October 2018, the CME exchange started trading in SONIA futures. In October 2018, CME became the world’s first platform to start regular clearing of OTC SOFR swaps, with a maximum contract duration of 30 years. The contract terms allow the exchange of fixed payments in lieu of SOFR, as well as payments in USD LIBOR against SOFR and the effective federal funds rate (EFFR) against SOFR. In October 2017, LCH started clearing of interest rate swaps based on SARON. EUREX was the first to launch SARON futures trading in 2018.
It is anticipated that the publication of LIBOR rates may be stopped from 2022. All working groups and market participants are working to ensure that the full transition to alternative rates does not lead to losses on LIBOR instruments.
The first issue of FRN bonds based on a risk-free rate was held by the European Investment Bank in June 2018. This is a 5Y issue at GBP 1 bln, the interest rate depends on SONIA+0.35%. This was followed by the issues from the US government agency Fannie Mae with reference to SOFR in July 2018 (with maturity of 0.5 years, 1 year, 1.5 years). Then new issues in SOFR and SONIA started to appear several times a month.Margin - Margin is a fixed part of the floating interest rate. For example, if the rate is 50bp over LIBOR, the Margin is 50bpMosPrime Rate - MosPrime Rate is the National Foreign Exchange Association (NFEA) fixing of the reference rate based on the offer rates of Russian Rouble deposits as quoted by the leading participants of the Russian money market to first class financial institutions. MosPrime Rate is an independent indicative rateNear-Risk Free Rates - Near-Risk Free Rates (RFRs) are overnight benchmark rates based on real transactions and linked to the money market. RFRs are also often related to as simply “risk free rates”.
SARON (Swiss Average Rate Overnight) is a weighted average interest rate of the secured funding in Swiss francs. The rate reflects real transactions and quotes for repo transactions in Switzerland, which are concluded on SIX Swiss Exchange.
SARON was created on August 25, 2009 with historical data available since June 30, 1999.
SARON is continually calculated in real time and published every 10 minutes. In addition, SIX publishes SARON fixing at 12:00, 16:00 and on closing at 18:00. The average daily trading volume in 2018 was around CHF 3.2 billion.
In 2017, the National Working Group on the Reference Rate, representing the participants of the Swiss financial market, proposed SARON as an alternative as part of the LIBOR CHF reform. This measure is a step towards the transition to risk-free rates as part of the global reform of interest rate benchmarks.
It is believed that SARON is a better indicator than CHF LIBOR, since SARON reflects both concluded transactions and binding quotes on the Swiss repo market.
Until June 13, 2019, the Swiss National Bank set the upper and lower limits for the fluctuation of the three-month CHF LIBOR, but now the regulator takes into account only the new SARON benchmark and sets the limits for its fluctuations.
Switzerland was the first country where the regulator began to use the new risk-free rate as an instrument of its monetary policy. In October 2017, the LCH clearing platform began to clear SARON interest rate swaps, and in 2018, the largest exchanges EUREX and ICE Futures Europe launched futures trading.
In September 2019, Credit Suisse Group issued first SARON-linked bonds on the Swiss market. These are Tier 1 bonds, which pay a fixed rate of 3% until 2025, and then the rate is SARON + 3.957%.
Each business day, the Federal Reserve Bank of New York calculates and publishes the SOFR at approximately 8:00-8:30 a.m.
SONIA (the Sterling Over Night Interest Average) is the representative of the risk-free rate and a successor to GBP LIBOR.
SONIA is the amount of interest paid overnight on obligations with minimal credit risk, liquidity risk and other risks. SONIA is calculated every business day in London based on the transactions entered into between the financial institutions. The rate administrator is the Bank of England. The calculation methodology was approved on April 23, 2018 after several meetings with market participants.
The first issue of FRN bonds based on SONIA was held by the European Investment Bank in June 2018. This is a 5Y issue at GBP 1 bln, the interest rate depends on SONIA+0.35%.
Some issuers amends terms of outstanding LIBOR linked floates and change rates to daily compounded SONIA, for instance after bondholders approving LLOYDS BANK effective on October 7, 2019 change the terms of its covered bond issue maturing in 2024.WIBOR - Warsaw Interbank Offered Rate€STR -
€STR(Euro Short-Term Rate), formerly called ESTER, is a rate that reflects the weighted average cost of unsecured overnight borrowing in the interbank market of the euro area.
In 2018, €STR was proposed as a new risk-free rate of the money market, which replaces three risk rates: EUR LIBOR, EURIBOR, EONIA. Replacement of the rate is related to the ongoing reform of benchmarks in the world.
Despite the fact that the rate was developed in 2018, its first publication took place only on October 2, 2019. Until that moment, pre-€STR was published – a rate calculated on the basis of data and methodology of the “real” €STR.
The €STR is administered by the European Central Bank. The ECB collects statistical information on money market activities in the European Monetary Union and publishes it in the MMSR. The €STR is calculated on the basis of the weighted average volume of transactions of 50 MMSR participating banks, trimmed by 25% of the top and bottom limits of the volume. A proportional calculation is applied to volumes that overlap with trimming thresholds to ensure that exactly 50% of the total allowable volume is used when calculating the weighted average volume.
The European Central Bank publishes the €STR of the previous business day on the next business day at 08:00 CET (TARGET2 calendar).
In 2019, the average daily volume of transactions on the basis of which the pre-€STR was calculated amounted to EUR 37 billion. This is more than 15 times the size of the EONIA transaction market. On average, pre-€STR is lower than EONIA by 8.5 bps.
Compared to EONIA, the €STR is more stable due to the larger number of participating banks, the larger volume of transactions and the trimmed volume principle when calculating the rate value. Besides that, among the features of the €STR, the opposite effect of the end of the month can be distinguished – the value of €STR falls at the end of the month, while the value of EONIA grows.
The London Clearing House will start clearing the €STR swaps on October 21, 2019.
A transition to discounting the fixed-period instruments at the €STR is scheduled for the second quarter of 2020.
FRNs based on the risk-free €STR were issued for the first time by the issuer Landeskreditbank Baden-Wurttemberg in September 2019. This is a 2-year issue for EUR 250 million, the interest rate depends on €STR + 2%.
Very often huge banks, which operate in some countries in different time and currency zones issue notes acting through its foreign branches in another country for certain legal (for instance tax), administrative and regulatory reasons, including (without limitation) to facilitate timely access to funding markets. In these cases interest payments maybe subject to applicable tax laws and regulations of the country of a branch location.
A branch is not a subsidiary and does not comprise a separate legal entity. The obligations under the notes issued by an issuer acting through its foreign branch are of an issuer only, and investors’ claims under notes are only against an issuer.
Foreign branch is obligated to follow the regulations of both the home and host countries, operating in the country.
Bank of China, which is regulated by the People’s Bank of China has got branches in European, Asian and American financial centres to fund its foreign currency needs in EUR, USD, JPY needs. Another example is Credit Suisse AG acting through its London branch.Guarantor - A guarantor - is a party who guarantees to provide payment on a bond, loan, or other liability in the event of default. A guarantor acts as a co-signor of sorts, in that they pledge their own assets or services if a situation arises in which the original debtor cannot perform their obligations. Guarantors reduce the risk to loans and liabilities, and usually improve the credit ratings of bonds.International Finance Corporation - is an independent branch of the World Bank, formed in 1971 for investments in the private sector of the countries, following the privatization path.Investor - is any person who commits capital with the expectation of financial returns. Investors utilize investments in order to grow their money and/or provide an income during retirement, such as with an annuity.Issuer - A legal entity that develops, registers and sells securities for the purpose of financing its operations.Market maker - is a broker-dealer firm that assumes the risk of holding a certain number of bonds of a particular security in order to facilitate the trading of that security. Each market maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of bonds, and once an order is received from a buyer, the market maker immediately sells from its own inventory or seeks an offsetting order.MILA - MILA (The Mercado Integrado Latinoamericano) is a platform that integrates the depositories and stock exchanges in Chile, Colombia, Mexico, and Peru. It was officially launched on May 30, 2011. The purpose of its creation is the development of the financial markets of member countries by providing investors with a wider choice of securities, issuers, and larger sources of financing.Paying agent - Paying agent - an institution, usually an investment bank, that accepts funds from the issuer of a security and distributes them to that securitys holders. In bonds, it receives coupon payments, which it then gives to bondholders. A paying agent acts as an intermediary in these transactions, and receives a fee for these services.Rating Agency - is a profit organization providing the assessment of the issuers’ solvency, debt obligations, corporate governance quality, asset management quality, etc. The most well-known product of Rating Agencies is the assessment of solvency - credit rating. It reflects the risk of non-payment of a debt obligation and affects the interest rate, cost and debt obligation yield. In this case, a higher rating corresponds to a lower risk of non-payment.SPV or SPE - A special purpose vehicle (SPV) or special purpose entity (SPE) is a company that is created solely for a particular financial transaction or series of transactions.Stock Exchange - is an organization that provides some facilities: security exchange, IPO.The aim of the stock exchange is to help buyers of the stock find sellers of the stock. The big exchanges are LSE, NYSE, Nasdaq, Frankfurt Stock Exchange, Tokyo Stock Exchange, Shanghai Stock Exchange.Surety - An individual or corporation that guarantees the performance or actions of another. A surety , as a general rule, is a party to the original contract of the principal, he signs his name to the original agreement at the same time the principal signs, and the consideration for the principals contract is the consideration for the agreement of the suretys. The surety is therefore bound on his contract from the very beginning, and he is bound also to inform himself of the defaults of the principal debtor, and he is not in any part relieved from his obligations under the contract by the creditors failure to inform him of the principals default in the contract, for which contract the surety has become the security for.Syndicate - is a group of financial institutions, organized to carry out a particular transaction – an extention of a credit, placement of a bond issue.Syndication participant - Syndication participant is one of the banks providing the syndicated facilityThe United States Securities and Exchange Commission (SEC) - The Securities and Exchange Commission (SEC) is an independent agency of the United States federal government. The SEC holds primary responsibility for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, exchanges, and other activities and organizations, including the electronic securities markets in the United States. The mission of SEC is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.Underwriter - is a company or other legal entity that manages the securities issue and their distribution. Underwriter guarantees the issuer the revenue from the sale of securities, and actually buys securities. Typically, an investment bank acts as an underwriter.