The transition away from LIBOR was one of the largest documentary exercises the loan markets have undertaken. Thousands of facilities were amended or refinanced, and new risk-free rate conventions became standard. Several years on, risk-free rates are simply part of how the market works, but some practical questions still come up.
How risk-free rates work in loans
Unlike LIBOR, which was a forward-looking term rate, the main risk-free rates, such as SONIA for sterling, SOFR for US dollars and €STR for euros, are overnight rates. Loans referencing them typically use a compounded in arrears methodology, under which the interest for a period is only known shortly before the end of that period.
Term rates, such as Term SOFR, are available for some currencies and are widely used in US dollar lending. For euro loans, EURIBOR continues to be used, with €STR-based fallbacks.
Questions that still arise
- Operational readiness. Compounded rates require agents and lenders to run daily calculations and to provide borrowers with timely notice of amounts due.
- Lookbacks and observation shifts. The choice of lookback period and whether to use an observation shift affects both the calculation and the operational burden.
- Fallbacks. Facilities referencing term rates or EURIBOR need clear and workable fallbacks if the primary rate becomes unavailable.
- Hedging alignment. Mismatches between loan and hedging conventions can create basis risk for borrowers.
The LIBOR transition showed what the market can achieve when it works together on common standards.
Lessons for future change
The LIBOR transition showed what the market can achieve when it works together on common standards. A few lessons stand out:
- Start early. The facilities that transitioned most smoothly were those where parties engaged well ahead of key deadlines.
- Standardise where possible. Recommended forms and conventions reduced negotiation time and operational complexity.
- Bring operations in from the start. Documentary choices have real operational consequences, and agents and back offices need a voice in the drafting.
- Communicate with borrowers. Clear explanations of how new rates work helped borrowers understand and accept the changes.
Our resources
Our risk-free rate facility agreements, compounded rate drafting provisions and accompanying guidance remain available to members in the documentation library. Our IBOR pages bring together our historical transition materials, and our training courses cover risk-free rate mechanics for those new to the market.
