Major central banks and regulators worldwide are now in the process of transitioning from Interbank Offered Rates (IBORs) to Alternative Risk-Free Rates (RFRs), also referred to as Alternative Reference Rates (ARRs). Since LIBOR has the most exposure in the US, the United Kingdom, Europe, Switzerland, and Japan, these representative countries actively seek to develop possible LIBOR replacements.
Global financial regulators instructed markets to cease using LIBOR as a benchmark. In 2014, the Alternative Reference Rates Committee (ARRC) was formed to help address various concerns about the reliability and robustness of existing reference rates. The committee is tasked to explore and provide guidance on alternative rates and to develop corresponding transition timelines. The ARRC determined the Secured Overnight Financing Rate (SOFR) to be the US dollar replacement rate.
The London Interbank Offered Rate (LIBOR) is a reference rate banks use for unsecured short-term interbank lending. It serves as the benchmark for short-term interest rates and indicates the financial system’s health and stability.
11-18 banks estimate the rate at which they would borrow from other banks
Panel banks are asked for the rate they would charge other banks for a given currency and time.
Banks submit rates to Intercontinental Exchange (ICE) for overall LIBOR index calculation
ICE discards the highest and lowest submitted rates and calculates the mean of the remaining submitted rates
35 LIBORs are required each day. LIBOR is calculated for five different currencies (USD, EUR, GBP, JPY, CHF) and seven different maturities (overnight, one week, one month, two months, three months, six months, or one year).
Aside from being an indicator for interbank lending, LIBOR is also used as a benchmark for over-the-counter derivatives, exchange-traded derivatives, corporate bonds, business loans (syndicated and non-syndicated), floating rate notes, consumer loans such as mortgages, credit cards, autos, and securitizations.
Risk-Free Rates (RFRs) are benchmarks based on overnight deposit rates. It measures the cost of overnight borrowings through repo transactions collateralized with US Treasury Securities. A term rate is available for products that require a forward-looking rate.
Some overnight rates are unsecured with only a minimal credit spread while some are secured and exclude credit risk. As a result, secured and unsecured rates behave very differently, especially in times of stress. In addition, complexities rise due to the economic differences in LIBOR and the structural differences among the secured overnight rates corresponding to various currencies.
BBK follows the development and guidelines issued by regulatory bodies, including the Central Bank of Bahrain.
We continue to align our systems, processes, and infrastructure to address the new requirements. We have identified the
impacted areas and contracts and taken appropriate steps to minimize risks. The progress of the initiatives is being monitored
closely by the Bank’s senior management to ensure that our services remain uninterrupted and efficient.
If your facility or final rate fixing is before the below dates, it may mature naturally with no required action. This matter is subject to
the movement of rates or mutually agreed upon between parties:
Assess the overview of outstanding transactions/contracts between C ustomer and BBK that are in scope for transition repapering
Options on transition approach:
Active Conversion: Proactive negotiation for the conversion of transactions with BBK before the LIBOR cessation allows for custom outcomes in terms of timing and structure of transactions post-conversion.
Fallback Conversion: Allow existing LIBOR transactions to incorporate market standard fallback provisions triggered by a LIBOR cessation event.
The impact on the outstanding transaction(s) concerning transition repapering;
The approach of transitioning for these transaction(s);
Conventions to use when transitioning the transaction(s);
The operational procedure of transitioning the transaction(s);
The date on which the transaction(s) will be transitioned.
Appropriately pricing of the transactions that are in the scope of transition repapering.
Execute the transactions that are in the scope of transition repapering.
Continuing to provide customer support post transitioning, where relevant.
As the market transitions to SOFR, indexes or credit spread adjustments are emerging to help address market participants’ concern that SOFR does not have the embedded bank credit component included in LIBOR. Therefore, the all-in interest rate for a LIBOR-based loan is the LIBOR rate for the relevant term plus the bank’s commercial margin. In contrast, RFRs do not include a credit premium, so the industry is exploring the best possible route to mitigate the “rate difference’ risk and address the divergent
behavior between the benchmarks. The option is to derive a Credit Adjustment Spread (CAS) added to the Risk-Free Rate (RFR). Therefore, the all-in rate for a loan transitioned to Risk-Free Rates consists of three elements: The RFR, the CAS, and the agreed commercial margin.
The cessation announcement of LIBOR on 5 March 2021 (FCA announcement on future cessation and loss of representativeness of the LIBOR benchmarks) has resulted in the fixed credit adjustment spreads, and it is expected that a similar approach will be adopted for the CAS in the loan market.
For more information on the reform of benchmark rates, please visit the websites below, or you may reach out directly to your BBK Relationship
Manager. We will continue to update you on further developments on the interest rate benchmark reforms and transitions. The information presented here is not intended to be a complete or exhaustive overview.
Bank of Bahrain and Kuwait BSC (the ‘Bank’ or ‘BBK’) provides this information with the understanding that BBK is not rendering definitive legal, business, or financial advice to you as a client of the Bank. The Bank cannot assure you the outcome of any laws or regulations proposals in connection with LIBOR and how they might impact your product. Generally, working to transition your product from an IBOR rate actively will clarify your product’s rate after the cessation of that IBOR rate. You should now consider and continue to review the potential impact of any future changes to IBOR rates.
Although we make strong efforts to make our information accurate and up-to-date, BBK cannot guarantee that the data is always complete due to the fast developments in this sensitive matter. Therefore, please seek guidance from your advisors to be kept updated and well-informed with the developments regarding this transition.