The interbank market rates have served as a reference for floating rates for all borrowers for many years. Companies and individuals that incur debt at floating rates are also applied Interbank Offered Rates (IBORs), such as EURIBOR, LIBOR or TIBOR, depending on the currency, increased by a margin representing the borrower’s credit risk.
IBORs are determined on the basis of statements made by the participating banks of their average unsecured borrowing costs on the interbank market, for a given maturity and currency. Due to the reduction of unsecured interbank borrowings, these statements are now more based on estimates than actual transactions. This reduces their relevance and increases risks, as shown by the scandals surrounding the manipulation of LIBOR and EURIBOR.
Strict rules relating to benchmarks and their administrators have therefore been put in place. Moreover, the entire market will have to evolve from IBORs, which will disappear (the Financial Conduct Authority has already announced the end of LIBOR, planned for 2021), to alternative “risk-free” rates, which do not yet exist for all currencies.
Strict regulation for benchmarks and their administrators
Since 1 January 2018, Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on indices used as benchmarks, known as the “Benchmark Regulation”, imposes governance and control requirements to the administrators of benchmarks. These administrators must also apply a “robust and reliable” methodology that has “clear rules identifying how and when discretion may be exercised in the determination of that benchmark”.
In addition, the administrator must be listed on the new register held by the European Securities and Markets Authority (ESMA), after having been registered or authorised, depending on whether the benchmark is considered as critical, significant or non-significant. To this end, the Annex to the Commission Implementing Regulation (EU) 2017/2446 of 19 December 2017 considers that EURIBOR, EONIA and LIBOR are critical benchmarks.
Any issuer of securities or any other investment product admitted to trading on a regulated market and based on a benchmark is, from now on, required to include “clear and prominent” information in its prospectus as to whether the benchmark is provided by an administrator included in the register held by ESMA.
Regarding contributors, the input data that they provide to the administrator shall be sufficient to represent accurately and reliably the market or economic reality that the benchmark is intended to measure, with integrity and accuracy. Moreover, they must adhere to the code of conduct provided by the administrator.
The transition to alternative risk-free rates
The adoption of alternative risk-free rates to replace IBORs is not straightforward. Those that already exist have not been adopted as widely as their predecessors and certain IBORs, such as the EURIBOR, are still awaiting a successor.
There is a wait-and-see attitude and no standard fall-back clause has been provided for contracts, as of yet.
An initial approach consists in keeping current fall-back clauses, although these were primarily aimed at overcoming a temporary suspension of the benchmark rather than its total discontinuance.
Other clauses are also emerging which stipulate that, should a benchmark be suspended, a third party shall have the power to choose a replacement benchmark which is as close as possible to the initial benchmark, with an obligation to adopt the benchmark recognised by the market as being its successor if such a benchmark exists. This clause offers the advantage of guaranteeing the use of a floating rate until maturity of the financial instrument but leaves the choice of the replacement benchmark in the hands of a third party, exposing the parties to the risk of applying a benchmark whose movements may be very different from the initial IBOR.
The authorities concerned have put in place various working groups, notably in the EU, UK and Switzerland. On 1 February 2018, ISDA, AFME, ICMA and SIFMA jointly published a Roadmap setting out the current situation and the solutions proposed. On 25 June 2018, those professional bodies also published a report on the transition, based on a survey of 150 entities, which highlighted the significant amount of work that is still to be done.
Under French law, and even if there are no fall-back provisions in a contract, the parties are not left without a solution. Pursuant to Article 1167 of the French Civil Code, “where the price or any other element of a contact is to be determined by reference to an index which does not exist or has ceased to exist or to be available, the index is replaced by the index which is most closely related to it”.
One must continue to monitor this transition and anticipate it as the interbank rates are globally used, not just for banks but for all borrowers.