Benchmark rates in upheaval — replacement of LIBOR

On June 8, 2016, the EU Commission issued the EU Benchmark Regulation (BMR)* of the European Parliament and of the Council on benchmarks (reference rates). Benchmarks are referred to in financial instruments and contracts, and are also used to measure the performance of investment funds. The aim of the BMR is to ensure that the benchmarks provided and used in the EU are robust, reliable and representative.

The publication of LIBOR will be discontinued

Arguably the most important benchmark for global financial markets is the London Interbank Offered Rate (LIBOR) published by the ICE Benchmark Administrator. This is provided daily in different maturities for the 4 main currencies: Swiss franc (CHF), US dollar (USD), Japanese yen (JPY) and British pound (GBP). The UK regulator responsible for LIBOR, the Financial Conduct Authority (FCA), announced on March 5, 2021 that publication of CHF, JPY and GBP LIBOR will cease at the end of 2021, and that of USD LIBOR will cease on June 30, 2023.

New: Alternative reference interest rates

As a replacement, alternative reference rates (ARRs) have been established in the respective currencies. These are also referred to as Risk-Free Rates (RFRs). As a consequence of the LIBOR cessation, the LIBOR-linked interest rates of the affected contracts are switched to the economically closest alternative reference rate. 

LIBOR rates also include an interbank credit risk premium, which is absent from alternative reference rates. This is taken into account in the form of an adjustment spread (fixed by a recognized external organization on March 5, 2021). This type of adjustment ensures economic equivalence for both contracting parties.

The cessation of LIBOR interest rates does not only affect the conversion of existing contracts. Erste Group Bank, Erste Bank and Sparkassen will also follow the regulatory requirements regarding the use of benchmark rates when offering new products. We support the switch to alternative reference interest rates - and we support our customers in finding their way in an environment without LIBOR interest rates in the best possible way.

Disclaimer

The content of this page represents the current understanding of Erste Group Bank, Erste Bank and Sparkassen regarding the LIBOR conversion and is subject to change. This overview is neither complete nor conclusive. It is not a substitute for a detailed assessment of the impact on you or your organization by independent experts - and it does not constitute advice or a recommendation.

 

* Regulation (EU) 2016/1011 (https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32016R1011)

 

Questions & Answers about the discontinuation of LIBOR

LIBOR is the reference interest rate that banks use when lending money to each other for up to 12 months. This interest rate indicator is recalculated every day and is applied as the benchmark value for calculating interest in financial contracts.

LIBOR interest rates are mostly based on estimates made by experts and only partially on real-life market transactions. The EU Benchmarks Regulation only allows the use of transaction-based reference values in the future – to protect financial markets and consumers alike.

The discontinuation of LIBOR is a necessary measure to boost confidence in reference interest rates and to make it possible to offer financial products with variable interest rates in the future.

LIBOR will be replaced by so-called ARRs – Alternative Reference Rates. They are exclusively based on transactions, which makes them more transparent.

These new reference rates were developed by working groups consisting of market participants and supervisory bodies/central banks. They have different names according to the currency in question: SARON for the Swiss franc, SONIA for the British pound, SOFR for the US dollar and TONA for the Japanese yen.

However, these new reference rates do not contain all the risk mark-ups that were included in the LIBOR. For existing accounts or loans, we will therefore add a risk mark-up that is appropriate to the term and currency involved (adjustment spread). For new accounts or loans, this spread will be included in the interest rate from the beginning.

LIBOR has been used as the reference interest rate for calculating the interest on your account or loan.

To protect financial markets and consumers alike, the EU Benchmarks Regulation only allows the use of transaction-based reference values in the future. Once LIBOR ceases to be published, it can no longer be used as a reference rate.

LIBOR rates will cease to be published at the end of 2021 for the Swiss franc, the British pound and the Japanese yen. Publication for the US dollar will be discontinued in mid-2023.

Your loans/accounts will be automatically switched to the new indicator – the first time that interest rates are adjusted after LIBOR has been discontinued. You will be informed about the new indicator prior to the switch.

Such an interest rate is intended to ensure that the economic terms that were agreed in the original contract are retained – i.e. that neither you nor we are disadvantaged by, or benefit from, the new rate.

To ensure this, we must apply an appropriate risk mark-up (adjustment spread) to the new indicator. 

The exact switch from the discontinued LIBOR interest rates to the successor rates is currently not regulated by law. It is possible that a binding arrangement may still be introduced.

What is definite is that LIBOR may no longer be used. The resulting gap has to be filled by an indicator that is economically closest to the previous one so that the contract can continue to run. 

Yes, because the discontinuation of LIBOR means that market conditions are changing – and this could not have been foreseen at the time of contract conclusion. The contracts therefore need to be adjusted to reflect the changed market conditions to the best extent possible. For this reason, an indicator that is economically closest to the previous one has to be used.

Your US dollar account will be affected if it takes LIBOR as its reference interest rate – as LIBOR interest rates will cease to be published. Once this happens, they can no longer be used as reference rates.

LIBOR for the US dollar will be discontinued on 30.06.2023. This will affect 1-month, 3-month, 6-month and 12-month LIBOR terms.

No, EURIBOR is not affected by the discontinuation of LIBOR and will remain unchanged. There is an intention to change this – but it will only take place in the medium term, i.e. in about 3 to 5 years.

The new indicator should correspond as closely as possible to the LIBOR rate applied previously. For this reason, no change is expected as a result of the switch.

But in the same way as with LIBOR, the new indicator may change compared to the previous period at the time of the switch.

No, we will not be charging you anything for the switch.

No, there is nothing you need to do. The LIBOR rate will be replaced automatically by the successor indicator. Prior to the switch, you will receive an addendum to your existing contract, which doesn’t need to be signed by you.

As LIBOR interest rates will cease to be published, it is not possible to retain these rates. For this reason, you cannot object to the switch.

However, you can convert your foreign currency loan to a euro-based loan at attractive conditions at any time. Alternatively, you can repay your foreign currency loan ahead of maturity.

The current contracts remain in force. This is because at the time of contract conclusion, the discontinuation of LIBOR could not be foreseen, but is causing a change in market conditions now.

The existing contracts remain in force because the resulting contractual gap is closed by using a reference rate that is economically closest to the previous rate.

However, you can convert your foreign currency loan to a euro-based loan at attractive conditions at any time. Alternatively, you can repay your foreign currency loan ahead of maturity.

No, the switch will not have an effect on existing risks, because LIBOR is simply switched to the economically closest interest rate.

The risks therefore remain unchanged: risk arises mainly if income is denominated in a currency that is different from the currency of the loan or if interest rate fluctuations occur.

No. Until LIBOR is discontinued, there is no reason to change existing contracts, because the reference rate set in the contract will continue to apply. Changing the contract now would incur charges – but no charges will arise if the contract is changed automatically after LIBOR has been discontinued.

You can find the available successor indicators here:

In any case, the successor indicators will also be published by the respective administrators on their official websites.