As LIBOR is slowly being phased out universally, SONIA is the go to near risk-free rate. Read more about the challenges and responses required to make a smooth transition by December 2021.

1. The gradual
phasing-out of
LIBOR
RAHUL SINHA

2. CONTENTS
- What is LIBOR
- Historical background
- How is LIBOR calculated
- Rate-rigging scandal
- SONIA
- Major differences
- Key benefits of SONIA
- Challenges to phasing-out
- Measures to mitigate challenges
- Summary

3. What is LIBOR
London Inter-Bank Offered Rate
Benchmark interest rate for short-term lending between banks globally
Calculated & published each day by the Intercontinental Exchange (ICE)
A basis for interest on consumer loans, credit cards, car loans, adjustable-rate
mortgages, etc
Some MF & other securities around the world also tied to LIBOR rate
Used as discounting factor in commercial contracts worldwide
There are 35 LIBOR rates posted each day for each of 5 major currencies for loans of different maturity periods.

4. Historical background
1980 : Market for
interest-based
products began
evolving
British Bankers
Association (BBA)
sets up interest
settlement rates
1986 : Further
streamlining by
BBA let to BBA
LIBOR
2008 : Rate
rigging scandal
unearthed
following report
by WSJ
2014 : BBA LIBOR
changes to ICE
LIBOR

5. How is LIBOR calculated?
1.54%
2.36%
1.77%
2.81%
0.98%
3.63%
1.91%
2.77%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
Barclays Bank Of America CitiBank Deutsche Bank JPMorgan Chase UBS Goldman Sachs Morgan Stanley
US$ LIBOR interest rate calculation – maturity 12 month
The use of Trimmed-mean method helps
eliminate the influence of data points on the
tails that may unfairly affect the mean value.
After removing outlier observations, the trimmed mean is found using a standard averaging formula. In this case; 12-month $US LIBOR is calculated at 2.19%
Each morning just before 11 AM GMT, the ICE administration asks a panel of large banks
the rate at which they could borrow funds, if they were to borrow short-term funds from
other banks.

6. Rate-rigging scandal
•Major banks allegedly colluded to manipulate the LIBOR rates.
•They took trader’s requests into account and submitted artificially low LIBOR rates in order to
keep them at their preferred rates.
•Banks & financial institutions including Barclays, RBS, UBS, Deutsche Bank were faced with
regular scrutiny.
•Following a WSJ report, US Department of Justice launched investigations. Similar investigations
were launched in the U.K. and Europe.
•The scandal was one of the primary reasons why LIBOR shifted from BBA administration to ICE.

7. SONIA
• Overnight rate, set in arrears and based on actual transactions in overnight indexed swaps for
unsecured transactions in the Sterling market.
• Established in 1997 by the Wholesale Markets Broker’s Association (WMBA) in Great Britain.
• Calculated each business day in London, it is the weighted average rate of deals having a
minimum transaction value of 25 million British pounds (Sterling) brokered by members of the
WMBA.
• Widely used benchmark for many transactions
• In April 2017, the working group on Sterling Risk-free Reference Rates (which is a group of
active, influential dealers in the sterling interest rate swap market) announced that SONIA would
be its preferred risk-free interest rate benchmark.
• The Financial Conduct Authority (FCA), which is a regulatory body for financial markets in the
UK, announced it would no longer require banks to submit LIBOR quotes after 2021.

8. Major Differences
LIBOR SONIA
 Forward-looking term rate  Backward-looking overnight rate
 Based on transactions yet to happen  Based on transactions that have already
occurred
 Advanced visibility of finance costs  Transactions lack element of certainty

9. Key benefits of SONIA
Transaction-based Wholesale based
(beyond inter-bank)
Underpinned by 45-50
billion pound worth
daily transactions

10. Challenges to phasing-out
• Refinancing LIBOR-referenced loans
• Changing terms of contracts based on LIBOR
• Changing contracts to SONIA reference rate before the deadline date of 31 December 2021
• Financial and accounting adjustments will be needed to reconcile the shift
• Tax implications
• Huge amounts of money will be required to be spent by banks and institutions to put in effect
these change (approximated at $1.8 billion)

11. Measures to mitigate challenges
A gradual phasing out is required to uproot LIBOR. There are some measures to mitigate the
challenges this entails:
• Parties should set up in advance the terms of conversion on payment date
• Establishment of market conventions for SONIA compounded in arrears
• Due diligence on any existing contracts or interest swaps that include LIBOR provisions
• Revisit intercreditor agreements and make necessary adjustments regarding financial
• Open communication regarding ‘legacy contracts’
• Ensure implementation process is started well in advance of deadline date

12. Summary

13. SONIA is seen as preferrable to LIBOR since they are based on data from observable transactions
rather than on estimated borrowing rates.
Since LIBOR is omni-present in the financial world, transitioning to SONIA will come with its own
unique challenges. Over $350 Trillion (source : Economic Times) worth of contracts across the
globe are pegged to the LIBOR which is the key interest benchmark for several currencies. Many of
these contracts (legacy contracts) extend beyond 2021. The transition to alternative reference rates
will involve considerable efforts for LIBOR users for impact assessments, amending contracts and
updating systems.
As the end of 2021 is looming, firms must start to prepare to transition away from LIBOR as soon as
possible. It is recommended to conduct a thorough due diligence exercise on all relevant
documents to identify the scope of the project and then hold discussions and planning for
transition with all relevant counterparties. Internally, organizations need to identify systems and
processes that need changing and understand how the change will impact them economically and
from an accounting and tax perspective. Implementation may be complicated and have far-
reaching consequences and it would be sensible to start the process of transition with plenty of
time left.

14. Thank you
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