What are Ibors?
ISDA fallbacks protocol
In 2017, the UK Financial Conduct Authority (FCA) announced that it would no longer be necessary to persuade or compel banks to submit the rates required to calculate the London interbank offered rate (Libor) after 31 December 2021. This article discusses the implications of the cessation of Libor and looks at what it might mean for entities in Malaysia.
"Interbank offered rates" (Ibors) are benchmark interest rates that represent the average rate at which banks are willing to borrow wholesale unsecured funds. Libor is the most widely used interest rate benchmark in the world. It is often referenced in, among other things, derivative, bond and loan documentation. It also serves as a gauge of market expectation regarding central bank interest rates and liquidity premiums in the money markets, and, during periods of stress, as an indicator of the health of the banking system.(1)
Libor is administered by the Intercontinental Exchange Benchmark Administration (IBA) and calculated based on the submission of rates provided by a panel of 20 banks. The rates are submitted to, and used by, IBA for the overall LIBOR index calculation. Libor is calculated and published daily for five currencies(2) and seven tenors.(3)
As the method of determining Libor is based on submissions by panel banks, this means that it is subjective and open to manipulation.(4)
On 5 March 2021, the FCA, as the regulator of Libor, announced the timeline for its discontinuation.(5)
In view of the prospective discontinuation of Ibors, risk-free rates (RFRs) have been identified as an alternative. RFRs are all overnight interest rate benchmarks, and are therefore "backward-looking" and based on actual transactions. Ibors, on the other hand, represent interest rates for unsecured interbank loans across various tenors, so Ibors are "forward-looking" term rates that incorporate unsecured bank credit risk.(6)
The prospective demise of Ibors means that Malaysian entities (banks and corporates) that have existing Ibor-based loan and/or derivative contracts will have to renegotiate benchmark replacements and develop fallback provisions with their counterparties in an effort to reduce the consequential legal risks following the non-publication of the Ibors.
The International Swaps and Derivatives Association (ISDA) has created the ISDA protocol mechanism to amend the ISDA standard contracts on a multilateral basis.(7) On 23 October 2020, the ISDA published the ISDA 2020 IBOR Fallbacks Protocol and the IBOR Fallback Supplements to the 2006 ISDA Definitions, which came into effect on 25 January 2021.(8)
The protocol, read with the supplements, seeks:
- to incorporate either the terms of, or a particular defined term included in, the supplement in the terms of existing non-cleared derivative contracts referencing Ibors; and/or
- on the permanent cessation of the relevant Ibor, to replace references to the Ibor – or what ISDA calls "fall backs" – with the applicable new benchmark rates into an existing derivative contract, provided that the parties to the derivative contract agree to adhere to the protocol.(9)
Any party may adhere to the protocol.
The current Ibor used in Malaysia is the Kuala Lumpur Ibor (Klibor) which was introduced in June 1987.(10) Similar to Libor, the rates quoted for Klibor are based on submissions by appointed licensed banks or licensed Islamic banks, which indicate the rates at which the Klibor submitters are willing to lend ringgit funds for the relevant tenors and are mainly used as a reference for other products such as the floating leg of interest rate swaps, options, futures and structured products.(11)
Bank Negara Malaysia (BNM) has appointed the Financial Markets Committee (FMC) to oversee the development of a transaction-based alternative reference rate (ARR) for Malaysia and deliberate on the strategic direction for Klibor and the Kuala Lumpur Islamic Reference Rate (KLIRR).
The BNM indicated in its Financial Stability Review — Second Half 2020 that:
- the FMC will conduct a public consultation to gather feedback on the identification of a suitable ARR and enhancement of the Klibor framework if it is retained; and
- the publication of the ARR is expected to commence in the second half of 2021, pursuant to which banks can price their products based on ARRs.(12)
On 19 May 2021 the BNM issued a discussion paper(13) that addresses:
- the development of an ARR;
- refinements to Klibor;
- Ibor fallback language; and
- a review of the KLIRR.
For further information on this topic please contact Krystle Lui or Christina Kow at Shearn Delamore & Co by telephone (+60 3 2027 2911) or email ([email protected] or [email protected]). The Shearn Delamore & Co website can be accessed at www.shearndelamore.com.
(1) For further information, please see the ICE Benchmark Administration's overview on Libor.
(2) Sterling, euro, Swiss franc, Japanese yen and US dollar.
(4) This was proven to be true in the Libor scandal that occurred in 2012 when a bank admitted that its traders had submitted estimates that considered requests by colleagues and external traders which they did not believe to be precisely accurate. Further, the submission by that bank was also influenced by a desire to portray an image of its own liquidity that belied the difficulties it was then experiencing. For further information, please see K Toomey, "LIBOR", 1 October 2012, Journal of International Banking and Financial Law (2012) 9 JIBFL 538.
(5) The timeline for the cessation of Libor is as follows:
- after 31 December 2021 – all tenors for sterling, euro, Swiss franc and Japanese yen and one-week and two-month tenors for US dollar; and
- after 30 June 2023 – overnight, one-month, three-month, six-month and twelve-month tenors for US dollar.
For further information, please see the FCA's announcements on the end of LIBOR.
(6) The table below summarises the differences between Ibors and RFRs.
Various (overnight/spot, one week, one month, two months, three months, six months and 12 months)
Incorporate a spread
Minimal or none
(7) For further information, please click here.
(8) For further information, please see the ISDA's press release, "New IBOR Fallbacks Take Effect for Derivatives", 25 January 2021.
(9) For further information, please see the ISDA's response to question 2B to the ISDA 2020 IBOR Fallbacks Protocol (IBOR Fallbacks Protocol) FAQs, available here.
(10) Paragraph 1(1) of policy document on KLIBOR Rate Setting, available here.
(11) Paragraph 1(2) of policy document on KLIBOR Rate Setting.
(12) Page 7 of Financial Stability Review – Second Half 2020.
(13) The discussion paper can be accessed here.