*Investment and Financial Advisory Department- Treasury and Investment Sector

London Interbank Offered Rate (LIBOR), the benchmark reference interest rate used in global financial markets for pricing financial instruments including loans, securities, and financial derivatives, is calculated daily for a range of tenors that include over-night, one week, one month, two months, three months, six months and 12 months in US dollars, British pounds, Euros, Japanese yens and Swiss francs.

 The LIBOR is determined based on the average interest rates of unsecured funds, which represents the interest rates on deposits among a panel of pricing banks based on their expert judgement estimates. Accordingly, the credibility of such a pricing mechanism has been affected especially following the 2008 global financial crisis as supervisory bodies and global financial institutions lost confidence in LIBOR as a reference rate and instructed to adopt risk-free alternative reference rates.

By the end of 2021, LIBOR will no longer be published for the British pound, the Euro, the Japanese yen and the Swiss franc as well as for the US dollar (one-week and two-month tenors only), while the rest of the US dollar tenors will  continue to be published till the end of  June, 2023.

 The US Federal Reserve has issued the Secured Overnight Financing Rate (SOFR) which relies on actual US Treasury Repo Transactions as a risk-free alternative reference rate. while the SONIA (Sterling Overnight Index Average) is considered as a risk-free alternative refernce rate for the British pound and the ESTR (Euro Short Term Rate) for the Euro.

 Based on guidelines from a number of globally recognized supervisory bodies, international banks have formed internal committees at their end to study the impact of the transition from LIBOR on their own systems, as well as on the contracts and agreements with their customers. Accordingly, banks have started educating their customers about the transition from LIBOR for the sake of amending the existing contracts and agreements that reference LIBOR as a basis for pricing by including a Fallback Language/Fallback Clause that gives the banks the legal right to use alternative reference rates once LIBOR is discontinued.

As the risk-free alternative reference rates are for short-term periods (over-night), term premiums will need to be considered by banks through compounding such rates on a daily basis for the required tenors. Consequently, interest rates are now to be fixed at the end of the interest period instead of at its beginning, contrary to what is being applied in the case of using LIBOR, which requires the adoption of specific methods to determine interest amount before its due date in order to make customers aware of the amounts they are expected to pay ahead with an appropriate period of time.