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February 19, 2019

Libor transition

A detailed look into implementation challenges and current industry proposals

The global financial industry is currently in a substantial transition because of the planned discontinuation of the London Interbank Offered Rate (Libor) targeted for 2021. This process is guided by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) in the UK, the Federal Reserve Bank of New York in the US and corresponding regulators in other countries.


Regulators are focusing on banks to start the process of Libor replacement. Major jurisdictions have identified alternative risk-free rates that offer significant promise as benchmarks, giving an indication of short-term borrowing costs.


The International Swap and Derivatives Association (ISDA) and working groups for major currencies for Libor transition are assisting in the formulation of an alternative term structure and benchmark supplement annex to make the process smooth, which is essential to systemic stability. ISDA is amending the 2006 ISDA Definitions to include fallbacks that would apply upon a permanent discontinuation of the relevant inter-bank offer rate.


In this paper, we present a summary of alternative reference rates identified by regulators, analyse the challenges the industry is facing at this juncture and discuss how CRISIL can support institutions to transition smoothly.


In particular, we have conducted statistical analysis to show which rate may be the closest fallback option for existing Libor trades among the ISDA-suggested fallback methodologies. We also look at curve construction from first principles and apply the ICE Benchmark Administration (IBA)-suggested methodology for building a curve for the Secured Overnight Financing Rate (SOFR). We find the method of using future prices for SOFR a good fit – in alignment with the IBA – for the purpose of term structure creation.