London interbank offered rate (LIBOR) and other interbank offered rates (IBORs) have traditionally been used to set interest rates for various financial products such as loans, bonds and derivatives. The era of using IBORs may be about to come to an end as LIBOR is expected to cease to be published after 2021 and alternative reference rates are being identified and developed for other IBORs by relevant central banks across jurisdictions. As a part of this development the Riksbank has commenced a six-month test period for publishing SWESTR (Swedish krona Short Term Rate) as an alternative reference rate.
When lending is based on a floating rate, the interest rate is typically comprised of a certain margin increased by the relevant reference rate. The margin reflects the credit risk the lender evaluates it is taking when lending to a particular borrower whereas the reference rate theoretically reflects the lender’s costs for borrowing the relevant amount in the relevant interbank market.
The most common reference rates in use on the Nordic markets depending on the relevant currency have for a long period of time been STIBOR, EURIBOR, LIBOR, CIBOR and NIBOR. The use of these interbank reference rates (IBORs) has a relatively long history as LIBOR has been used since the 70’s and for example the templates of the Loan Market Association have been based on the specifics and the theoretical background of the IBORs. IBORs are based on interbank interest rates at which a selection of banks on the relevant money market are prepared to lend to one another unsecured for a certain period of time. IBORs are forward looking rates available for various terms such as tomorrow, one month, three months and six months. Since IBORs are theoretically based on lending between banks, each reference rate inherently contains bank credit risk and liquidity premium due to longer dated funds.
Today LIBOR is calculated and published for five currencies: sterling, U.S. Dollars, Euros, Swiss Francs and Japanese Yen, but this is destined to end as the Financial Conduct Authority (FCA) of the United Kingdom announced in summer 2017 that after 2021 it will no longer persuade LIBOR panel banks to submit the rates required in order to calculate LIBOR. The reason for this decision derives from the underlying market that LIBOR measures, which has not been an active market since the financial crisis. Therefore, there has not been sufficient liquidity to indicate actual relevant funding rates, but the rates have for years been based on expert judgments rather than market movements. This has consequently made interbank offered rates vulnerable for market manipulation as was evidenced during the revelation of the LIBOR scandal in 2012. The LIBOR panel banks are committed to submit the relevant rates until the end of 2021, whereafter LIBOR is expected to cease to be published (apart from potentially USD LIBOR as there have been recent plans to continue publishing USD LIBOR until June 2023). No decisions are made on cessation of rates such as EURIBOR, STIBOR, CIBOR or NIBOR but the expectation is that these rates may as well be replaced by alternative interest rates later on due to these rates being plagued by the same lack of liquidity as LIBOR making these rates unrepresentative of the relevant interbank market.
Various national working groups led by respective central banks have identified so called risk free rates as suitable replacement rates for the IBORs. Theoretically a risk free rate is a rate at which an investor would expect to be compensated for an investment with no risk of loss. In practice risk free rates are overnight rates derived from real transactions on active and liquid markets, which are subsequently calculated and published on the next day thus making the risk fee rates unlike IBORs backward looking rates. This means that in the beginning of an interest period a borrower does not know the actual amount of the interest. Other inherent features of risk free rates are that they should not include credit risk or liquidity premium, and therefore, risk free rates are expected to be lower than the corresponding IBOR. This does not mean that the shift from IBORs to interest risk free rates would affect how the banks fund themselves and therefore this decrease in the reference rates is not in practice expected to transfer to lower interest rates. Therefore, if parties wish to avoid value transfers, the banks have to consider whether to cover this gap by increasing the margins of the products using risk free rates or by adding a credit adjustment spread as an extra component on the applicable interest.
Risk free rates are being developed by central bank led working groups. So far the most notable nearly risk free rate are SONIA (Sterling Over-Night Indexed Average) in respect of sterling, SOFR (Secured Overnight Financing Rate) in respect of U.S. Dollar and €STR (Euro Short-Term Rate) in respect of Euro.
In Sweden no decision has been made in respect of non-continuation STIBOR. From May 2020 onwards Swedish Financial Benchmark Facility (SFBF) have taken over the responsibility of calculating and publishing STIBOR, with the aim of making STIBOR compliant with the Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 (the “Benchmark Regulation“) by the end of this year. STIBOR is registered as a so called “critical benchmark” in Sweden and in the EU Commission’s register since 2018 and critical benchmarks as well as their administrators must be compliant with the Benchmark Regulation by the end of 2021. Therefore, SFBF is to submit an application with Finansinspektionen to be admitted as “Administrator” under the Benchmark Regulation.
In the same manner as several other central banks also the Riksbank, being the central bank of Sweden, has undertaken the task of developing and publishing an alternative reference rate. On 27 January 2021 the Riksbank commenced a six-month test period for publishing SWESTR (Swedish krona Short Term Rate) which is a transaction based overnight rate. SWESTR shall not be used as reference rate in financial contracts during the test period, but the aim is to start publishing an official reference rate intended for use in financial contracts after the test period, and SWESTR could replace the current shortest reference rate, STIBOR Tomorrow-Next (T/N). The aim of the Riksbank is in future to start publishing average rates calculated on the historical daily listings for SWESTR which would be retrospective and compounded averages. These average rates for SWESTR are aimed to form a part of the so-called fallback solution for STIBOR, which means that the average rates for SWESTR could comprise the base for an alternative interest rate to use if STIBOR were to cease to be published during a contract period. However, no decision has been made to replace STIBOR in its entirety by introduction of SWESTR and it remains to be seen what the future of STIBOR and reference rates will be.