Reference rate update

In a few weeks all USD LIBOR tenors will cease to be published, and thus, any outstanding financing contracts referring to USD LIBOR should be scrutinised and action should be taken prior to the deadline in the end of June. On the other hand, STIBOR continues as the most common reference rate for Swedish krona despite the Riksbank’s invitation to start using SWESTR as the relevant reference rate.

USD LIBOR

On 30 June 2023 USD LIBOR will cease to be published for all its remaining tenors, and thus, any existing USD LIBOR contracts should be transitioned to refer to alternative reference rates, most often risk free rates such as SOFR or term SOFR, prior to that date. In order to facilitate the transition relevant supervisors have previously urged market participants not to enter into new contracts that use USD LIBOR as a reference rate after 31 December 2021. Based on our market visibility Swedish market participants have diligently followed this request and following the end of the year 2021 new financing contracts denominated in USD have had alternative reference rates.

After the end of June the Financial Conduct Authority (FCA) will continue to calculate a so called synthetic USD LIBOR for tenors of one, three and six months, but a synthetic LIBOR is not a representative rate, which is typically a requirement for a reference rate under finance contracts. Therefore, in practice synthetic LIBOR can only be used as a reference rate in contracts that have been entered into prior to the commencement of the discussions regarding LIBOR transition. The FCA has also prohibited all new use of synthetic USD LIBOR from 1 July onwards. Further, referring to synthetic rates will not provide for a long term solution as the FCA intends that publication of the synthetic USD LIBOR settings will cease on 30 September 2024.

Therefore, to the extent a finance contract still refers to USD LIBOR as a reference rate an amendment agreement should be entered into to agree on and incorporate the relevant alternative reference rate together with the mechanical changes needed to cater for the alternative rate. In principal a transition from LIBOR rates to risk free rates should not change the total amount of interest. As a forward looking interbank offered rate LIBOR theoretically contains an element of pricing based on the assumption that one bank is taking credit risk on the other bank for the relevant tenor. This is not the case with risk-free rates, and thus, in order to avoid value transfer in connection with transition to risk free rates and to achieve a neutral outcome usually an adjustment spread corresponding to the risk and term premium is added to a risk free rate. Alternatively, a higher margin can be used in connection with risk free rates in order to achieve a balanced outcome.

In the absence of agreement to amend a finance contract referring to USD LIBOR, LMA based finance contracts would fall back under the so called cost of funds -clause wherein the lenders would request for interest payment corresponding to their actual costs. A cost of funds -clause is a market standard clause aimed at securing a way to determine pricing at the times when due to short time market disruption reference rates cannot be obtained. However, in a long run this would be administrative burden for all parties and would lead to unpredictable and most likely less beneficial pricing for the borrower.

STIBOR and SWESTR

STIBOR as an interbank offered rate is still the relevant reference rate for Swedish krona widely used in connection with various financing transactions. Currently no resolutions have been passed to cease the publication of STIBOR. STIBOR is also a critical benchmark under the Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 (the Benchmark Regulation). In order to comply with the requirements set out by the Benchmark Regulation for administrators of the critical benchmarks, the Swedish Financial Benchmark Facility lodged an application with the Financial Supervisory Authority in the end of December 2021 and on 21 April 2023 the Swedish Financial Benchmark Facility was granted the authorisation. The Swedish Financial Benchmark Facility was advised by Cederquist – you can read more of the successful project behind this link.

In addition to STIBOR, the Swedish central bank (the Riksbank) has been publishing SWESTR (Swedish krona Short Term Rate), a transaction-based reference rate calculated by the Riksbank on the basis of transactions executed on the money market from one banking day to the next in Swedish kronor. The Riksbank has also actively encouraged market participants to use SWESTR instead of STIBOR as reference rate for overnight lending and in the longer run the Riksbank would opt for STIBOR to cease to be published for all tenors. So far we have not seen SWESTR widely used as a reference rate in commercial financing transactions. In January 2023 Swedish Export Credit Corporation issued a SWESTR linked bond, which has been the first SWESTR linked bond on the Swedish market, but in the big picture market participants still tend to prefer STIBOR.