Shift from LIBOR to ARR(Alternative Reference Rate)

Shift from LIBOR to ARR(Alternative Reference Rate)

The Reserve Bank of India (RBI) earlier this month encouraged banks and financial institutions to stop entering into new contracts as per LIBOR or the London Interbank Offered Rate. Financial institutions will have to stop considering LIBOR as a reference by December 31, 2021. Banks have been asked to consider any other widely accepted ARR or alternative reference rates.

This comes after a 2014 Financial Stability Board report highlighted incidents of attempted market manipulation along with fake reporting of global reference rates that undermined the confidence in the robustness of existing inter-bank benchmark interest rates.

Moving away from LIBOR

The RBI also urged banks and financial institutions to stop their customers from entering into new contracts with LIBOR as a benchmark. Remember, LIBOR is used by financial institutions across the world as reference rates for several financial products and contracts.

RBI announced the decision in a circular and said that banks must uphold customer protection and take care of any litigation risks involved. The Central Bank has asked banks and financial institutions to review all direct and indirect LIBOR exposures and chalk out a new framework that mitigates all the risks that crop up from such exposures. Banks will, first of all, need to come up with infrastructure to be able to offer new contracts with alternative reference rates as the benchmark.

The RBI has also laid the onus on banks to sensitize customers about the transition from LIBOR and the alternatives being brought in.

However, some US-dollar LIBOR settings will continue to be in place until June 30, 2023. To this, the RBI says that its main objective is to ensure the roll-off of legacy contracts linked to the US-dollar LIBOR. RBI says that the contracts that can be drawn as per LIBOR after the December 31, 2021 deadline must be only for managing risks arising out of LIBOR contracts.

MIFOR

Along with LIBOR, banks have also been encouraged to stop using MIFOR or the Mumbai Interbank Forward Outright Rate by December 31, 2021. Published by Financial Benchmarks India or FBIL, MIFOR is a benchmark used for legacy contracts and fresh contracts. Just like LIBOR, banks may continue to use MIFOR after the December 31, 2021 deadline only for risk management activities such as hedging.

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