coworkers using calculator

LIBOR transition: What it means to your credit union

LIBOR transition: What it means to your credit union

Synopsis
5 Minute Read

Much of the financial world is transitioning away from its reliance on the London Interbank Offered Rate (LIBOR). Leaders at credit unions need to be aware of what comes next.

Global financial markets are constantly changing as inflation, economic pressures from the pandemic, and the war in Ukraine create much uncertainty. If you work in the finance or treasury space within your credit union, staying on top of what could affect you down the road is tough. If you’re a smaller credit union, but one that has some complexities, keeping up is even more of a challenge as finance resources may not be available to unpack these trends and their corresponding impacts.

Global benchmark reform efforts have sought to improve the foundations of financial products around the world, which includes the transition of LIBOR to other reference rates. Here in Canada, Canadian Dollar Offered Rate (“CDOR”) will cease by June 28, 2024.

What is LIBOR?

The London Interbank Offered Rate (“LIBOR”) is an unsecured interbank borrowing rate that relies on the panel banks to submit the interest rates that they would have to pay to borrow from each other. LIBOR is based on five currencies (USD, Euro, GBP, JPY, and CHF) and seven different maturities ranging from overnight to 12 months, leading to a total of 35 different LIBOR rates being calculated and reported daily. LIBOR is computed by removing the highest and lowest figures, making it essentially a trimmed average of answers from the panel banks.

Globally, over $350 trillion worth of financial contracts are tied to LIBOR. It has been regarded as the most important number(s) in finance.

The Downfall of LIBOR

The challenge with LIBOR is that the practice created incentives for manipulation. LIBOR became the rate underpinning trillions of dollars of derivatives contracts and banks that trade derivatives built up large positions. On any given day, some banks (or their traders) may wish for a higher LIBOR while other banks wish for a lower LIBOR, depending on their derivatives position. This created an incentive for the banks to manipulate LIBOR through the rates they submit, which then led to scandals with several large banks paying fines of over $9 billion.

LIBOR Transition

In 2017, the United Kingdom’s Financial Conduct Authority (“FCA”) announced it will no longer compel banks to submit rates for LIBOR beyond 2021. On March 5, 2021, the ICE Benchmark Administration (“IBA”), the current administrator for LIBOR, announced that it will stop publishing LIBOR as of the dates below:

LIBOR Currency LIBOR Tenors Final Publication Date
USD 1W, 2M December 31, 2021
USD All other tenors June 30, 2023
GBP, EUR, CHF, JPY
All tenors
December 31, 2021

Here in Canada, financial institutions and companies transacting in Canadian dollars are more familiar with the CDOR. It’s a daily reference rate for Bankers’ Acceptance (“BA”) borrowings. The Canadian BA market exists primarily within Canada and, at about 20 percent of the overall money market, constitutes the largest sector of the Canadian dollar money market after Government of Canada treasury bills. If your organization enters a Canadian dollar denominated interest rate swap, the underlying index is most likely CDOR.

CDOR is also used for exchange-traded funds, loans, and floating rate notes. The current administrator of CDOR is Refinitiv Benchmark Services (UK) Limited (“RBSL”). On May 16, 2022, RBSL announced that the calculation and publication of all tenors of CDOR will permanently cease after June 28, 2024.

The new rate in town

Replacing LIBOR are so called risk-free rates (“RFRs”) that are a broad measure of the cost of borrowing cash overnight. Unlike LIBOR, RFRs are not based on answers submitted by panel banks, but rather based on large volumes of observable overnight lending transactions.

The RFR for U.S. dollar is SOFR (Secured Overnight Financing Rate), for British pound sterling SONIA (Sterling Overnight Index Average) and for Canadian dollars CORRA (Canadian Overnight Repo Rate Average). CORRA measures the cost of overnight general collateral funding in Canadian dollars using Government of Canada treasury bills and bonds as collateral. It is reported every business day by the Bank of Canada between 9:00 and 11:00 EST.

By the end of June 2023, all market participants are expected to transition new derivative and security contracts or transactions from CDOR to CORRA in-arrears. No new CDOR exposure will be booked after that date with limited exceptions. For instance, you will be allowed to continue to transact in new CDOR-based loans, with robust CDOR fallbacks, until the cessation of CDOR on June 28, 2024. You can continue to hedge CDOR-based loans with CDOR-based derivatives until this end date.

Several Canadian banks have already issued in-arrears CORRA-based floating-rate notes, and Canada Mortgage Bonds have been moved to using in-arrears CORRA for their floating-rate note issuance starting in May 2022. The Canadian Alternative Refence Rate (“CARR”) working group expects the bond market will increasingly move to using in-arrears CORRA as the primary benchmark. 

How are risk free rates different from LIBOR/CDOR?

  • LIBOR is a term rate and is set prior to the commencement of the interest period to which it relates. This allows a borrower to budget as they would be able to calculate at the outset of the interest period the amount of interest required. Most RFRs such as SOFR and CORRA are backward looking and are published the day after the period to which they relate. Depending on the calculation method chosen, the borrower may only know how much interest is owed on the interest payment date, or very close to it.
  • LIBOR reflects term risk and bank credit risk and RFRs do not reflect either; therefore, RFRs are lower than LIBOR over the equivalent period.
  • LIBOR is administered in London and is published daily at 11:00 a.m. London time. RFRs are each administered locally in each currency jurisdiction and published at different times.

Consequences and challenges

With any major change, there are tremendous challenges that come with it. To transition away from LIBOR or CDOR to RFRs, you should consider several points. For example, which method of calculation you should apply (payment delay, lockout, last rest or 5-day lookback), what credit adjustment you should be making to account for the difference between LIBOR/CDOR and RFRs, what consents you will require, and the impact on hedging.

MNP is here to help

Financial concepts such as LIBOR can be complex and require detailed expertise to proactively determine how you should be adapting to mitigate risk.

Contact us

To learn more about how MNP can help your organization navigate this transition, contact our Credit Unions team.

Insights

  • Confidence

    December 03, 2024

    Give and take: The impact of fraud on non-profit organizations

  • Progress

    November 28, 2024

    Building career paths for dealership employees: The key to retention and succession planning

    Building career paths for dealership employees is the key to tackling two critical workforce challenges: high turnover and looming retirements.

  • Progress

    November 28, 2024

    Tax alert: How the federal GST/HST tax holiday will work

    Get the latest on the federal GST/HST tax holiday, including qualifying items, certain exclusions, and other qualifying criteria.