Understanding the LIBOR Transition

As the world moves away from using LIBOR, here’s what your business needs to know.

Why the London Interbank Offered Rate (LIBOR) is Being Replaced

LIBOR is a benchmark rate that’s used to calculate interest in a variety of financial contracts. It’s been used around the world for decades, and shows up in commercial loans, derivatives, small business transactions, and even some consumer products like student loans.

Today, U.S. dollar LIBOR is the most popular global benchmark for short-term interest rates, and represents $200 trillion of financial contracts and securities. But industry experts have started seeking LIBOR alternatives, due to changes in the rate’s transparency and reliability.

Over time, the underlying market that determines LIBOR has stopped having a significant transaction volume. This means LIBOR is often based on the judgement of a panel of banks rather than on robust market data, impacting its credibility.

For those reasons, LIBOR is being phased out over the next few years. After December 31, 2021, ICE Benchmark Administration (IBA) will stop publishing all non-USD LIBOR rates and some USD LIBOR rates. As a result, Capital One will stop originating new products using LIBOR by the end of 2021. By the end of June 2023, banks won’t be required to submit the information that’s used to calculate USD LIBOR. With LIBOR on its way out, the industry is leaning towards the Secured Overnight Financing Rate (SOFR) as a replacement.

Replacing USD LIBOR with a Transaction-Based Rate: SOFR

While there are a number of reference rates that could take USD LIBOR’s place, SOFR is the leading contender to replace USD LIBOR. Based on a few key factors, it's the official recommendation of the Alternative Reference Rates Committee (ARRC), the U.S. industry group convened by the Federal Reserve Board and the New York Fed that is guiding the LIBOR transition. 

The main difference between SOFR and LIBOR is how the rates are produced. While LIBOR is based on panel bank input, SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities in the repurchase agreement (repo) market. The transaction volumes underlying SOFR regularly are around $1 trillion in daily volumes. The Repo market’s large transaction volume gives the ARRC confidence that SOFR will be reliable through a wide range of market conditions, making it a good long-term option to replace LIBOR.

picture of chart comparing differences between libor and sofr

Top 5 Things to Know

As the industry moves away from LIBOR, your business will need to take the necessary steps to prepare. Get started by watching the top 5 things you should know about the LIBOR transition.

How Capital One Can Help You Prepare

At Capital One, our priority is supporting clients transitioning out of LIBOR. We’re staying informed and prepared so we can help make the process as smooth as possible for your business.

To do this, we’re actively participating in industry forums like the ARRC and International Swaps and Derivatives Association (ISDA) to stay up-to-date on the transition. Throughout 2021 we'll also be working with you to amend existing loans and derivatives to SOFR and updating contracts with suitable fallback language to help keep your business running smoothly.

Go Deeper on the LIBOR Transition

Take a look at our FAQs below for additional details on LIBOR, SOFR, and how to prepare your business ahead of the transition.

For any additional questions, please reach out to your Capital One Commercial Bank Relationship Manager.

LIBOR Transition FAQs

LIBOR, the London Interbank Offered Rate, is a popular benchmark index rate worldwide. Banks use LIBOR to determine interest payments for financial products like commercial loans and derivative products. LIBOR is the most commonly-used global benchmark for short-term interest rates, and it’s currently referenced in approximately $200 trillion of financial contracts and securities.

There are concerns about the validity and transparency of LIBOR. The rate is calculated on a limited number of market transactions, making it based more on the judgement of a panel of banks rather than on data.

Additionally, the ICE Benchmark Administration (IBA) is taking steps to phase out LIBOR. In December 2021 they’ll stop publishing non-USD LIBOR rates and the 1 week and 2 month tenors of USD LIBOR, and after June 2023, banks won’t be required to submit information used to calculate USD LIBOR rates. For these reasons, the financial industry is seeking a LIBOR alternative.

SOFR, the Secured Overnight Financing Rate, is the leading contender to replace USD LIBOR (but hasn’t been declared the only alternative). Whereas LIBOR is more dependent on expert judgement of panel banks, SOFR is based on data from observable transactions in the marketplace. For more key facts about LIBOR vs. SOFR, please see our comparison chart above.

Since LIBOR is referenced in many different types of financial contracts, moving away from the rate could impact a variety of businesses and individuals. This could include:

  • Corporate and municipal borrowers financing operations with LIBOR-based floating rate loans and/or bonds
  • End-users hedging risk with LIBOR-based derivatives
  • Investment banks underwriting, issuing and making markets in LIBOR-based instruments
  • Investors managing portfolios of swaps, bonds and loans tied to LIBOR
  • Consumers with mortgages or student loans tied to LIBOR[1]
  • Certain credit cards that use LIBOR

This transition is happening worldwide. Outside the US, several other markets are also transitioning away from their relevant currency IBOR to an overnight, risk-free rate. The countries below are expected to transition to various alternatives by the end of 2021.

  • United Kingdom’s leading option is Sterling Over Night Indexed Average (SONIA)
  • European Union's leading option is Euro Short-Term Rate (ESTR)
  • Canada’s leading option is Canadian Overnight Repo Rate Average (CORRA)
  • Japan’s leading option is Tokyo Overnight Average Rate (TONAR)

At Capital One, we’re committed to making the LIBOR transition as smooth as possible for our clients. To do this, we’re taking a proactive, enterprise-wide effort approach, closely following the industry discussions, and investing significant additional resources to prepare for the change. Some specific steps we’re taking:

  • We’ve assembled a comprehensive team with representatives from areas across our company to work on the effort.
  • We’ve been adjusting our operating systems, training our associates, and updating documentation language (e.g. hardwired fallback language) so we’re prepared to offer the leading U.S. alternative rate, SOFR.
  • Our team is actively participating in industry forums like the Alternative Reference Rates Committee (ARRC), International Swaps and Derivatives Association (ISDA), and Loan Syndications and Trading Association (LSTA) and incorporating their published recommendations into our transition approach where appropriate.

As the transition away from LIBOR approaches, Capital One, National Association is working with customers to choose a transition approach that is suitable for their business. Customers can choose to amend or refinance existing USD LIBOR loans and derivatives to SOFR-based rates and update contracts to include suitable fallback language. 

As of April 1, 2021, Capital One, National Association has adopted hardwired fallback language for recently originated or modified LIBOR loans that specifically identifies SOFR as the new reference rate and details the mechanism for transition at LIBOR cessation on June 30, 2023. This language also describes the spread adjustment to be used to account for differences between LIBOR and the new reference rate.

For all current deals using LIBOR, hardwired fallback language defines the path to transition to a new benchmark interest rate once LIBOR is phased out. Once hardwired fallback language is introduced, no other amendments to the loan agreement are needed.

The primary change will be the replacement of the LIBOR index with the SOFR index plus a spread adjustment. This avoids the need to re-underwrite the facility and preserves the original margin spread.

For a derivative associated with a LIBOR-based loan, a Capital One, National Association Derivatives Marketer will assist with the remediation process to transition from LIBOR and answer any questions you may have about the derivative transaction and remediation.

Your LIBOR-based derivatives products will need to incorporate appropriate fallback language to address the LIBOR transition. 

To handle the transition of derivative products from LIBOR, the International Swaps and Derivatives Association (ISDA) recently published standardized legal documentation that enables the transition through robust fallback language. This fallback language adopts SOFR to replace USD LIBOR, and adds a credit spread adjustment to account for differences between USD LIBOR and the new reference rate.

As a result of public statements on March 5, 2021 by the ICE Benchmark Administration (the “IBA”), the administrator of LIBOR, and the UK Financial Conduct Authority, the regulatory supervisor of the IBA, that set forth the dates when certain LIBOR settings will cease to exist or become non-representative, the fallback language has been triggered; however, existing contracts that incorporate the fallback language will switch from LIBOR to the fallback rate until the actual date that the relevant LIBOR setting(s) ceases to exist (e.g., for USD LIBOR overnight, one month, three month, six month and twelve month tenors, after June 30, 2023).

As of January 25, 2021, ISDA’s standardized legal documentation amends their standard definitions for interest rate derivatives to incorporate robust fallbacks for derivatives linked to certain IBORs. From that date on, all new cleared and non-cleared derivatives that reference ISDA’s standard definitions for interest rate derivatives include the new fallbacks, with no additional action needed from you.

Additionally, ISDA published the ISDA 2020 IBOR Fallbacks Protocol to which swap counterparties can adhere to. This convenient mechanism enables adherents to the protocol to incorporate the fallbacks into non-cleared derivatives trades entered into prior to January 25, 2021 with other adherents. As of January 13, 2021, Capital One, National Association has adhered to this protocol.

For more information on swaps, please see the Capital One Libor Transition Additional Information page.

For any derivatives trades that were executed before January 25, 2021, the borrower counterparties have two options:  

  1. You can adhere to the ISDA IBOR Fallbacks Protocol. In this case, USD LIBOR-based terms of the derivative transaction will automatically transition to SOFR (compounded in arrears) plus a credit spread adjustment on the transition date without requiring additional amendment or negotiation. 

  2. You can negotiate with Capital One, National Association to bilaterally amend your derivatives trades to incorporate adequate fallback language to address the USD LIBOR transition.

From the date upon which LIBOR ceases to exist, the LIBOR rate referenced under your swap will be changed to a risk free rate (e.g., SOFR) plus a credit spread adjustment.  

For swaps entered into on or after January 25, 2021, the International Swaps and Derivatives Association (ISDA) finalized changes to its standard derivatives definitions detailing new fallback provisions to address the LIBOR transition.

For those swaps entered into prior to January 25, 2021, ISDA has published a 2020 IBOR Fallbacks Protocol that enables adherents to the protocol to amend such legacy swap contracts to include the new derivatives fallback provisions.

Under these ISDA LIBOR fallback provisions, the USD LIBOR replacement rate will be SOFR (compounded in arrears) plus a credit spread adjustment based on the 5 year median spot difference between USD LIBOR and SOFR. 

For more information on swaps, please see the Capital One Libor Transition Additional Information page.

Starting in Q4 2020, Agency Finance stopped originating loans in LIBOR and began offering loans in SOFR.

Capital One is prepared to offer SOFR-based products now and will stop originating new products using LIBOR as a benchmark interest rate by the end of 2021. We plan to transition all of our existing USD LIBOR-based products by June 30, 2023.

We’re here to support you in staying updated and prepared for any impact the LIBOR transition may have on your business. For now, we recommend taking the following steps:

  • Evaluate your systems capabilities to ensure they accommodate the different risk-free rate accrual methods.
  • Determine how your business might be impacted if an exact interest payment amount is not known until the end of the month.
  • Be aware that, per the IBA, some tenors (1 week, 2 month, and non-USD) will no longer be offered after December 31, 2021 while others are extended to June 30, 2023. And, per regulatory and ARRC guidance, we will no longer issue LIBOR based products beyond December 31, 2021.
  • Additionally, be aware that for any new LIBOR-based products the agreement will likely include hardwired fallback language, enabling the shift to an alternative benchmark rate upon LIBOR cessation.
  • Review industry resources such as the ARRC and ISDA website for additional information and updates.