What is IBOR?
IBOR, which stands for Inter Bank Offered Rate, is the interest rate at which banks lend to and borrow from one another in the interbank market.
What is LIBOR?
LIBOR is the London Interbank Offered Rate. LIBOR is one of a number of IBORs that are widely used in the financial markets, including as a reference rate to a vast number of derivatives, bonds, loans, securitisations, and deposits. Other IBORs include EURIBOR for Euro and USD LIBOR Rate for Dollar transactions.
How is LIBOR Calculated?
LIBOR is calculated and published daily across five currencies (GBP, USD, EUR, JPY and CHF) and seven maturities (overnight, one week, and 1, 2, 3, 6 and 12 months) by the Intercontinental Exchange Benchmark Administrator (ICE BA).
It’s based on submissions by a panel of banks using available transaction data and their expert judgement. LIBOR should provide an indication of the average rate at which each LIBOR contributor can borrow unsecured funds in the London interbank market for a given period, in a given currency. This average is published and used by the financial markets.
Why are IBORs being replaced?
International regulators began focussing on IBOR reform since 2013. With the number of interbank unsecured borrowing transactions reducing in recent years, there has been an increasing reliance on the expert judgement of panel banks on which to base LIBOR.
This has led to concerns that LIBOR is no longer a representative or reliable benchmark reference rate. Between now and the end of 2021, the global financial markets will transition away from using interbank offered rates (IBORs) in financial contracts.
What will replace IBORs?
International regulators are encouraging the development and adoption of “Risk-Free Rates” (RFRs) which are currently proposed to be overnight and term free. Working groups have been established across all major currencies to select alternative overnight rates with four already selected:
1. SONIA (GBP)
2. SOFR (USD)
3. TONAR (JPY)
4. SARON (CHF)
Markets are already beginning to adopt these rates; there has been an increase in the volume of SONIA-referenced swaps in the market as well as recent examples of primary issuance of bonds referencing SONIA or SOFR.
How are we responding?
NatWest Group supports the market transition from LIBOR. We’re working closely with our regulators, market participants, industry bodies and trade associations, to make sure the transition is as smooth as possible.
What is SONIA?
SONIA (Sterling Over Night Indexed Average) is an overnight rate, set in arrears and based on actual transactions in overnight indexed swaps for unsecured transactions in the Sterling market. SONIA is a risk-free rate meaning no bank credit risk is included.
SONIA is expected to replace GBP LIBOR across global financial markets by the end of 2021.
Is SONIA a Term Rate?
SONIA is an overnight rate, not a term rate.
A term rate provides borrowers with a known interest rate for the period of borrowing and therefore provides up-front certainty of the amount of interest due at the end of the interest period. Some borrowers may find this helpful for their cashflow forecast.
SONIA is an overnight rate, based on actual market rates and reset on a daily basis in arrears; this removes any expectation of future events inherent in a forward-looking term rate.
SONIA is likely to be a less volatile rate known only at the end of the borrowing period and borrowers may favour this over a more volatile term rate known at the start of the borrowing period.
There is some industry discussion about the possibility of creating a forward-looking “term SONIA” rate. However, the potential scope of where such a rate may be preferable, the methodology for its creation, and the timing of its introduction, all remain uncertain. The advice from the FCA is that firms should not wait for, or rely on, the development of any potential term SONIA rate.