North America IBOR transition: “Endgame,” or is it? | Insights

In order to explain the implications of this year’s transition milestones, it’s helpful to first understand the key shortcomings driving the IBOR’s cessation.

Following the Global Financial Crisis (GFC) and the LIBOR manipulation scandal, credit-based interbank rates came into the spotlight. RFRs were seen as the answer to the industry’s calls for a more robust interest rate benchmark as an alternative to LIBOR. As a result, the next decade was focused on reforms aimed at strengthening the robustness of IBOR benchmarks and the creation of a new risk-free rate following the guidance of the Financial Stability Board (FSB), the Alternative Reference Rates Committee (ARRC), the International Organization of Securities Commission (IOSCO) principles, among many others.

While LIBOR, CDOR and TIIE are all unsecured forward-looking term rates which incorporate a bank’s credit and term risk (e.g., 1, 3, 6 month), there are key distinctions in what they measure and reflect. LIBOR and TIIE are banking borrowing rates, that is, the rate at which banks believe they can borrow from other financial institutions. Meanwhile, CDOR is a committed lending rate that reflects the rate at which banks are contractually willing to provide credit via a primary Bankers Acceptance loan facility. A key shared issue is that they were and are all survey-based rates based on judgment and not on specific transactions.

Although interbank rates served the global markets well for decades, the limitations gave rise to the creation of SOFR and the TIIE de Fondeo, as well as the strengthening of the decades old CORRA benchmark to be compliant with the IOSCO principles. These new RFR attempt to address the IBOR’s shortcomings via several key features. First, they eliminate bank credit risk and serve as a near risk-free rate because they are collateralized by their respective government debt. These include U.S. Treasury securities for SOFR, Government of Canada bills and bonds for CORRA, CETES and Mexican Bonds for the TIIE de Fondeo. Additionally, they mitigate any misrepresentation risk by the panel of experts because they are calculated and determined based on transaction data from the repurchase agreement (repo) market. Finally, as overnight rates, SOFR, CORRA and TIIE de Fondeo do not contain term risk premium. In sum, the new benchmark rates reflect the cost of overnight cash collateralized by liquid debt securities issued by their respective governments.

However, these new rates come with their own set of challenges. For instance, since daily RFR are backward-looking in nature, their final payment is determined at the end of the compounding period. This creates a challenge for corporations that require certainty on their upcoming interest cash receipt or payment. This led to the development of different forward-looking Term RFR’s such as the 1-, 3-, 6-, 12- month CME Term SOFR and the 1-, 3- month Term CORRA. As of this writing, there are some restrictions on loan products and in the execution of derivatives referencing Term RFRs. Currently, end user clients such as corporations can obtain loans and trade derivatives for hedging cash products referencing these forward-looking rates, however, liquidity providers are restricted to hedge this risk directly in the interbank market.

Where are we now in the North America IBOR transition?

In June 2023, the Canadian market reached an important milestone with the completion of the first stage of the CDOR to CORRA transition plan. One key element covered during the first stage was the transition of liquidity away from CDOR to overnight CORRA for new derivatives. After this stage, new derivatives tied to CDOR cannot be traded, unless it can be proved that this new CDOR swap reduces existing CDOR risk.

In 2024, Canada is on track to complete the second stage of its transition plan, with the cessation of the publication of CDOR by the end of June. End users and financial market participants should see progress in the development of the forward-looking 1- and 3-month term CORRA benchmarks based on the futures market, as well as the trigger of CDOR fallbacks for any remaining CDOR based exposure. In other words, because there will not be a synthetic CDOR publication, existing CDOR based loans need to be amended to reference either term CORRA + credit spread adjustment or the standard daily compounded overnight CORRA + credit spread adjustment

In Mexico, the TIIE transition has been bumpy as key cessation dates are likely prone to be extended. Regardless of the latest January 2025 waiver extension period for the 28-day TIIE cessation, there will likely be some progress on the fallback-conversion of legacy TIIE swaps to the synthetic 28-day TIIE equivalent (daily compounded TIIE de Fondeo to term + 24bps). In addition, this year should mark the start of the liquidity transition on the derivatives market towards the new TIIE de Fondeo benchmark. Additionally, 2024 will see the end of the less liquid TIIE benchmarks, 91- and 182 days, as no new agreements can be referenced to those rates.

The IBOR transition also comes with changes regarding administration, publication, and data accessibility of the new RFR benchmarks. While market participants can access RFRs through each participating Central Banks’ online resources, they also need reliable vendors to support a smooth transition away from IBORs. Since the sunset of LIBOR was announced in 2017, Bloomberg has worked closely with clients and the industry to develop a comprehensive suite of solutions spanning data, analytics, pricing, curves and reporting along with the expertise to help clients navigate this transition.

Bloomberg’s Multi-Asset Risk System (MARS) supports pricing and analytics based on a range of alternative reference rates (ARRs), including official-sector-endorsed risk-free rates (RFRs), including scenario analysis to determine the impact of transitioning to RFRs on portfolios. On the Terminal, Bloomberg offers trading services in cash securities and derivatives referencing RFRs. Bloomberg also publishes term and spread adjustments for the fallbacks that ISDA has implemented for certain IBORs. For more information, visit Bloomberg.com/Libor.