What the end of LIBOR means for bond investors

LIBOR has long been one of the most widely used reference rates for short-term lending. Some industry estimates put the credit tied to it, from mortgages to bonds, at around US$350 trillion. However, regulators decided to phase LIBOR out from the end of 2021. One reason was the 2012 manipulation scandal involving several global banks. In addition, markets have changed since LIBOR began. As a result, alternative reference rates (ARRs) have become the new standard. Below, we explain what the end of LIBOR means for bond investors.

How alternative reference rates differ from LIBOR

Alternative reference rates are near risk-free overnight rates. They aim to reflect market liquidity more accurately than LIBOR did. The main ones are SONIA (GBP), SOFR (USD), €STR (EUR), SARON (CHF) and TONA (JPY). Central banks administer most of them. In contrast, SIX Swiss Exchange administers SARON.

LIBOR reflected the credit risk of the banks that submitted it. In addition, ARRs draw on actual daily transactions rather than bank submissions.

Because ARRs carry little bank credit risk, they typically sit below LIBOR. Therefore, many contracts add a spread adjustment to bridge the gap. Of course, no fixed adjustment can match LIBOR exactly in every market.

What the end of LIBOR means for bond investors

In our view, many bondholders may see a modest impact. Issuers generally seek to narrow the gap between LIBOR and the new rates. Even so, coupon income, pricing or liquidity may still change. However, no single procedure applies, because each contract has its own features. As a result, its terms and conditions largely determine how the transition works.

Bonds that lack fallback language

Some corporate bonds have no fallback rate language. In those cases, issuers may need to call a holders’ meeting to amend the floating rate clauses. Instead, some may call the bond, which can leave holders facing reinvestment risk. Meanwhile, in the US, the LIBOR Act of 2022 set a default replacement for certain contracts without workable fallbacks.

Where fallback language exists

Other bonds include this language in their prospectus. For these, the issuer usually only needs to notify holders of the new reference rate. The most common fallbacks are an ARR or a fixed coupon based on the last LIBOR rate used. Consequently, a fixed coupon may no longer track market conditions.

Key transition dates

ICE Benchmark Administration (IBA) administers LIBOR. In late 2020, it consulted on keeping certain US dollar settings until June 30, 2023. By some estimates, around 60% of LIBOR contracts used dollars. The consultation closed on January 25, 2021. Next, the UK Financial Conduct Authority confirmed the end dates below in March 2021.

First, these settings ended on a representative basis after December 31, 2021:

• EUR LIBOR (overnight, one week, 1, 2, 3, 6 and 12 months)
• CHF LIBOR (spot next, one week, 1, 2, 3, 6 and 12 months)
• JPY LIBOR (spot next, one week, 1, 2, 3, 6 and 12 months)
• GBP LIBOR (overnight, one week, 1, 2, 3, 6 and 12 months)
• USD LIBOR, one week and 2 months

In contrast, EURIBOR is a separate benchmark and continues after reforms.

Finally, the remaining USD LIBOR settings ended after June 30, 2023:

• USD LIBOR, overnight, 1, 3, 6 and 12 months

Temporary ‘synthetic’ versions of some tenors covered certain legacy contracts for a time and have since ended.

Our approach

In practice, our investment committee works with custodians to monitor issuer notices on reference rate changes. If you have questions about what the end of LIBOR means for bond investors like you, please speak with your advisor.

This article is for educational purposes only and is not investment advice or a recommendation. Outcomes can vary by bond.