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Risk-Free Rates: It’s Not All About LIBOR

One of the consequences of the infamous rate rigging scandals that emerged in the early 2010s is that the London Inter-bank Offered Rate (LIBOR) has been earmarked for replacement. By 2021, regulators aim to have phased out LIBOR in favor of Risk-Free Rates (RFRs) including: the Secured Overnight Financing Rate (SOFR); the Euro Short-Term Rate (€STR); the Swiss Average Rate Overnight (SARON); the Tokyo Overnight Average Rate (TONAR), and; the Sterling Overnight Interbank Average Rate (SONIA).

Make no mistake, the introduction of these new rates is a significant change for the markets. After all: $240 trillion-worth of derivatives, loans and bonds are currently priced off LIBOR. However, with so much attention focused on the sunsetting of LIBOR and its replacement RFRs, there is a danger of firms ignoring the impact of changes on the broader, global landscape of interest rate benchmarks.

Driven by a mandate from the G20, the Financial Stability Board (FSB) encouraged a broad-brush review of all interest rate benchmarks – not just LIBOR – with the intention of ensuring their reliability and robustness whilst securing the availability of alternative RFRs. Based on credible, transaction-based data and subject to appropriate controls and governance, RFRs are intended to be used as fallbacks or replacements to IBORs in various jurisdictions therefore reducing vulnerability and overall systemic risk.

Already, there have been a number of major reforms outside of LIBOR. For example, the Prague Interbank Offered Rate (PRIBOR) and the Copenhagen Interbank Offered Rate (CIBOR) have transferred ownership to new, independent benchmark administrators, with the aim of increasing transparency and the robustness of the rates. Meanwhile, the Association of Banks in Singapore (ABS) have announced that the Singapore Overnight Rate Average (SORA) will be the preferred benchmark borrowing rate within the next two years. Again, transparency and good governance were cited as drivers behind the move.

What’s clear is that such reforms are just the start. Looking ahead, more change is on the horizon. For instance, the Norwegian Overnight Weighted Average (NOWA) is on the verge of being taken over by Norges Bank – the central bank of Norway. Similarly, the Canadian Overnight Repo Rate Average (CORRA) is ticketed to be taken over by the Bank of Canada. Both are attempts to put the rates on firmer ground.

Very rapidly, the IBOR regime that has underpinned financial markets for years is being transformed. The change is to be welcomed as it will introduce a new breed of benchmark rates that are robust, reliable and resilient to market stress. However, the move also presents considerable challenges to financial sector firms using the rates. Sufficient suitability and availability of term structure for RFRs are key areas that need to be monitored closely.

Constantinos Demetriou, Product Manager at RIMES explains: “Given the pace and scale of change, firms are going to be hard pushed to keep up. There’s also a real danger that with all the attention focused on transitioning LIBOR, some companies are going to miss the wider changes taking place in the market.

“This is where working with a managed data service provider like RIMES comes into its own. RIMES continually monitors the landscape on clients’ behalf, sourcing new data and adjusting to any changes the moment they occur. Working with RIMES, clients are insulated from the changes being wrought by RFR reform through a single up-to-date source for all Risk-Free Rates.”

RIMES’ Fully Managed Benchmark Data Service for Blends offers a strategic and flexible managed solution for blended benchmarks across multiple asset classes. Contact us to learn more.

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