LIBOR Transition

In 2018, the Federal Reserve’s Alternative Reference Rate Committee (ARRC) selected the Secured Overnight Financing Rate to replace USD LIBOR, the main reference rate used in credit instruments in the U.S. With more than $200 trillion of financial instruments based in USD LIBOR, the transition to an alternative reference rate should be followed closely.

CoBank and the Farm Credit System have been working diligently with several bodies responsible for providing feedback on the functionality of the financial system with a new reference rate. This page features some educational materials and resources to learn more about LIBOR and potential changes coming to the industry.

Life After LIBOR: Is the LIBOR Transition for Business Loans Finally Accelerating?

  • Borrowers are frustrated by the selection of SOFR as the recommended alternative reference rate for USD LIBOR
  • Lenders are critical of the structure of SOFR
  • Some are critical of SOFR interest calculation methodologies that include daily compounded interest calculations
  • There is inconsistency between the SOFR derivative markets
  • Several factors have changed the characteristics and volatility levels of SOFR

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Questions and Answers

What is LIBOR?

LIBOR (London Interbank Offered Rate) indexes are an estimate of the cost of borrowing/lending for banks on an unsecured basis. The rates are currently determined each day based on rate submission from panel banks and published by the ICE Benchmark Administrator (IBA). Although reference is often made to the LIBOR interest rate (singular), there are actually 35 different LIBOR interest rates for seven different maturities and for five different currencies.

How important is LIBOR?

U.S. Dollar LIBOR (USD LIBOR) is the dominant reference rate for financial instruments, particularly floating rate loans. The size of the contracts indexed to USD LIBOR is estimated to be more than $225 trillion. Many floating rate loans in the rural agriculture and rural infrastructure sectors currently use USD LIBOR as the index for floating rate transactions.

What is changing with LIBOR?

U.S. and international banking regulators have been expressing concern about LIBOR since the financial crisis in 2008. The primary concern is that the lack of a deep and liquid market in unsecured intra-bank transactions has reduced the reliability of LIBOR indexes and stated the market needs to transition to an alternative reference rate for floating rate transactions.

On March 5, 2021, LIBOR’s primary regulatory, the United Kingdom’s Financial Conduct Authority (UK’s FCA) and the indexes’ administrator, the IBA formally announced that all primary USD LIBOR tenors will either be discontinued or declared non-representative as of June 30, 2023. Under the LIBOR fallback provisions in most loans, the legacy LIBOR loans will continue to be indexed to LIBOR until their first interest reset date after June, 30, 2023. After that date, most loans will transition to an alternative reference rate plus a spread adjustment.

Recently, U.S. banking regulators (including the Farm Credit Administration) issued supervisory guidance encouraging banks to transition away from using USD LIBOR as soon as practicable and in any event by Dec. 31, 2021. The regulators stated the following:

  • With respect to new financial contracts entered into before Dec. 31, 2021, the regulators instructed banks/associations to either utilize a reference rate other than USD LIBOR or have robust fallback language in such new contracts that includes a clearly defined alternative reference rate after LIBOR’s discontinuation.
  • With respect to new financial contracts entered into after Dec. 31, 2021, the regulators instructed banks/associations that it will consider new instruments indexed to USD LIBOR, as a safety and soundness issue. The statement did include some exemptions for institutions for hedging and meeting obligations under legacy contracts.
Has an alternative reference rate been proposed?

The Federal Reserve convened the Alternative Reference Rate Committee (ARRC), which has recommended the creation of an alternative called the Secured Overnight Financing Rate (SOFR) as a replacement benchmark rate in 2017. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities and is completely transaction based. The Federal Reserve Bank of New York began publishing SOFR trading data on April 3, 2018.

The ARRC’s revised recommended LIBOR fallbacks for business loans contains a waterfall for selection of the alternative reference rate and is as follows:

Benchmark Replacement Waterfall
Step 1: Forward-Looking Term SOFR and Adjustment
Step 2: Daily Simple Average SOFR and Adjustment
Step 3: Lender Selected Rate and Adjustment

Note the Forward-Looking Term SOFR rate does not currently exist and will need to be derived from transactions in the SOFR derivatives market. The indexes will be published by a third party administrator under an approved/endorsed calculation methodology. The ARRC stated in the 2020 LIBOR Transition Key Objectives that they hoped to begin publication of the Term SOFR indexes in mid-2021.

On March 23, 2021, the ARRC stated they will not be in a position to recommend a forward-looking SOFR Term indexes by mid-2021. Additionally, the ARRC also stated they cannot guarantee that it will be in a position to recommend an administrator that can produce robust Term index by the end of 2021.

What's next in the LIBOR transition process?

On March 9, 2021, the ARRC released a statement confirming that under the ARRC’s business loan fallbacks a “Benchmark Transition Event” has occurred and triggered the provision of the ARRC fallbacks based on the March 5, 2021 announcements. It is worth noting that clarification by the ARRC might also have triggered some of the notice provision for certain transactions.

CoBank has been working with current borrowers to ensure appropriate fallback language is included in all loans. The fallback addendums are mostly based on ARRC recommended language.

Additionally, these statements also confirmed that the date of determination of the USD LIBOR spread adjustments per the International Swap and Derivatives Association (ISDA) LIBOR fallbacks was March 5, 2021. These spread adjustments will be applied to the alternative reference rates on the first rate change after June 30, 2023. The ARRC also stated they intend to utilize the exact same fallback spread adjustment for cash products as the ISDA regardless of the type of SOFR utilized. The fallback SOFR spread adjustments are shown below:

ISDA's SOFR Spread Adjustment for USD LIBOR
TenorSpread
1-Day0.00644%
1-Week0.03839%
1-Month0.11448%
2-Month0.18456%
3-Month0.26161%
6-Month0.42826%
12-Month0.71513%

U.S. banking regulators (including the Farm Credit Administration) issued supervisory guidance encouraging banks to transition away from using USD LIBOR as soon as practicable and in any event by Dec. 31, 2021.

  • With respect to new financial contracts entered into before Dec. 31, 2021, the regulators instructed banks/associations to either utilize a reference rate other than USD LIBOR or have robust fallback language in such new contracts that includes a clearly defined alternative reference rate after LIBOR’s discontinuation.
  • With respect to new financial contracts entered into after Dec. 31, 2021, the regulators instructed banks/associations that it will consider new instruments indexed to USD LIBOR, as a safety and soundness issue. The statement did included some exemptions for hedging and meeting obligations under legacy contracts.

As a consequence, CoBank will be offering customers both USD LIBOR and SOFR loans through most of 2021, but will not be able to offer new USD LIBOR indexed transactions after December, 31, 2021.

Please contact your CoBank Relationship Manager to discuss the LIBOR transition of your existing loans and the SOFR based loan products which CoBank now offers.

What is CoBank doing with regard to this issue?

As members of several industry-wide committees and regulatory advisory committees, CoBank and other Farm Credit institutions are actively monitoring and participating in discussions with industry groups and financial regulators about the transition of LIBOR as a benchmark for floating rate transactions. CoBank, on behalf of the four Farm Credit Banks, submitted multiple responses to consultations from the ARRC, the CME Group, the Commodities Future Trading Commission and ISDA for their consideration. Additionally, CoBank is working with our members to ensure they understand the implications of the index transition, that the loans are properly documented and alternative reference rate products are available for our members.