Ten years have passed since the outbreak of the scandal related to the manipulation of the LIBOR (London Inter-Bank Offered Rate) by employees of some financial institutions. LIBOR was the most important indicator for five currencies – pound, dollar, euro, yen and Swiss franc, fixed in one place – London. In addition to the fact that the LIBOR Index was the reference rate for mortgage loans, it also played a very important role in the debt market, and related financial instruments were valued in billions of dollars. A court in London, which in 2015 sentenced the former trader to 14 years in prison for his role in manipulating LIBOR, found that the manipulation of the LIBOR market had been ongoing since at least 2006. In connection with this sentence, fines were also imposed on several of the largest financial institutions on the international market, including one of them for the amount of over USD 1.5 billion. The total amount of fines exceeded USD 10 billion. All this time, preparations were made for the replacement of the most important benchmarks in the world, which finally took place on January 1, 2022. As LIBOR became an important tool in the financial markets, there was a growing temptation to influence the value of the indicator on which the results of financial institutions depended. The weakness of this ratio was due to the fact that it was calculated on the basis of the declarations of the largest banks regarding the interest rate at which they are willing to lend money to each other. This led to allegations of a lack of monitoring whether these data actually reflect the cost of capital. To address these concerns, the EU Benchmark Regulation (WMD Regulation) was adopted in June 2016 to improve the management and control of the benchmarking process, in particular with regard to conflicts of interest, and to improve the quality of input data and methodology.
The BMR Regulation defines the principles on which benchmarks are developed and the principles of supervision over institutions that develop them and make them available to financial market participants, including banks. As a result, from the beginning of 2022, LIBOR permanently disappeared from the financial market and was replaced by indicators based on market data and actually concluded transactions. The new indicator is known as the risk-free reference rate (RFR). The SONIA indicator was introduced in the pound sterling market. It includes all the transactions in the unsecured overnight market, on the basis of which the average is calculated. On the other hand, the USD exchange rate is indexed by the Secured Overnight Financing Rate Data (SOFR), and the SARON benchmark for the Swiss franc. It is calculated on the basis of the repo market average, but unlike the SONIA ratio, it applies to secured transactions. The undoubted advantage of the new benchmarks is the transparent method of their calculation and resistance to manipulation, supported by the BMR Regulation, which states that the output data on the basis of which the index is calculated refer to “transactions, if available and adequate”. At the same time, if the transaction data do not reflect the market or economic reality with sufficient accuracy and reliability, the regulator allows the use of estimated data.
As a result of the reform, the entire financial sector is faced with many challenges. For example, instead of a single LIBOR ratio, banks are now confronted with different rate calculation methodologies. In the case of the Polish market, there was a discussion about the compliance of the WIBOR index with the BMR Regulation. GPW Benchmark, the company that manages the index, is of the opinion that WIBOR complies with the BMR regulation regulating the benchmark market, and compliance is ensured from the management side, i.e. all procedures by the index administrator and fixing participants. The ongoing public debate on this subject and the risk of abusive clauses relating to benchmarks may, however, induce market participants to start work on the reform of benchmarks also in Poland.
An economic analysis of the contracts already concluded is certainly needed. Changing the ratios on which individual settlements are based may affect the profitability of individual products and the terms of financing agreements concluded before LIBOR’s transition to the RFR, including in particular the syndicated loan market. Indicators based on overnight transactions may not reflect the attitude of financial institutions to the debt market in the longer term, as they do not necessarily take into account a number of risks that arise with longer loan periods. In addition, syndicated loan agreements usually provide for interest periods of one or three months and the calculation of the RFR based on overnight transactions should therefore be adjusted accordingly. The syndicated loan market association (LMA) has published a comprehensive set of guidelines and documentation for the transition from LIBOR to RFR, including recommended documentation templates. The standard approach is to use a compound interest rate of the RFR with a lookback period of five business days, which means that interest for a given interest period is calculated on the basis of a period ending five business days before the actual interest payment date. This means that the amount of interest due is known in advance. Other approaches, such as those based on forward swaps, are also possible and parties to a loan agreement or other financing document should carefully consider which method to use, bearing in mind its economic and legal implications.
Source: The author is a Senior Associate in the Banking and Finance team at Wolf Theiss. He has over 12 years of professional experience gained in international law firms
