Q&A

Content

Introduction

General (background)
Why do we need a new reference interest rate?
What is happening internationally?
What has been done in Sweden?
What is an interbank rate?
What is a reference rate?
How and when will the new reference rate be introduced?

Transition
Will Stibor be discontinued?
How will existing contracts with a reference to Stibor be affected by the introduction of a new reference rate?
What is meant by fallbacks?

Longer-term reference rates
What is the difference between Stibor 3m and the new reference rate?
How have other countries dealt with the issue of longer-term reference rates?
Will a longer-term reference rate be created in Sweden?
What happens if Sweden does not have the market conditions to produce a longer-term reference rate?

About AGAR (Working group for alternative reference rates)
Why was AGAR formed?
Who are the members of AGAR?
What is the objective of AGAR’s work?
How does AGAR maintain contact with the market?
How does AGAR maintain contact with other working groups?

Introduction

The Working group for alternative reference rates (AGAR) reports here a number of questions and answers relating to the work being carried out by the Working group to draw up a recommendation for a new reference interest rate.

Reference rates are used in contracts, for example, in order to have a neutral interest rate as a basis, which no party is able to influence. They play an extremely important role in the global financial system.

In Sweden, there is now a requirement for fallback solutions for benchmarks when benchmarks are used in financial contracts according to the Benchmarks Regulation. Regulation began after manipulation of Libor and Euribor was uncovered in 2012. The new regulations may mean a change to Ibors in order to comply with new regulations or may lead to Ibors being replaced by new reference rates. Reference rates play an extremely important role in the global financial system and there must be great confidence in them.

Work is underway at the Swedish Bankers’ Association to develop a new alternative reference rate. At the same time, separate work is underway to develop Stibor in order to have it approved by the Swedish Financial Supervisory Authority on the basis of the new regulations (the Benchmarks Regulation).

General (background)

Why do we need a new reference interest rate?
Confidence in Libor and other Ibors has fallen internationally as the interbank market has deteriorated. The manipulation of Libor and Euribor that took place has also damaged confidence in Ibors. Ibors play an extremely important role in the global financial system and there must be great confidence in them. In order to strengthen confidence in all types of reference rates in financial contracts, the EU has introduced a Benchmarks Regulation, which also applies in Sweden. This regulation requires, among other things, there to be an alternative to the benchmarks used.

In 2012, it was discovered that there had been manipulation of the way in which Libor and other Ibors were determined. The interest rate had been manipulated by a few people at banks in London. This led to calls from supervisory authorities and global authority associations for Ibors to be subject to closer analysis in the future. In particular, it was found that the underlying interbank markets had not functioned as intended since the loss of confidence between banks since the Lehman crisis of 2008. Banks no longer carried out as many unsecured transactions between one another. There was no longer any real interbank market for the Ibors to reflect.

This problem was exacerbated by central banks in many parts of the world supplying liquidity to the markets in order to bring down interest rates, which also led to banks having less incentive to do business with one another. Regulatory requirements were also introduced that made the banks less willing to lend money to one another.

Generally speaking, there were forces at play that caused the interbank markets to shrink in most parts of the world. This was particularly noticeable for slightly longer terms. There is still an interbank market, however, for the shortest terms.

The weak interbank market has led the authorities to conclude that the use of Ibors in financial contracts needs to be replaced or supplemented by other reference rates that are based on transactions made on liquid markets. This opinion was first put forward by the Financial Stability Board in a report in 2014, in which they called these interest rates nearly risk-free rates (RFR).

New reference rates have been developed in the larger currency areas. For Sweden to continue doing business with parties in these larger currency areas, it is helpful if Sweden also has a similar interest rate to those developed in these areas. This will enable payment flows for futures to be handled when other countries have reference rates that are nearly risk-free rates (RFR) and the parties may have difficulty doing business with references to Ibors.

It is also important to emphasise that there is now a regulatory framework in Europe in the form of the Benchmarks Regulation (BMR) . In order for a benchmark to be used in a financial instrument, this benchmark must comply with the Benchmarks Regulation and must have an administrator with authorisation under the BMR. All Ibors used in Europe must undergo such a process and be approved. Stibor must also be approved.

What is happening internationally?
Working groups have been established in most countries to develop alternative reference rates that are virtually risk-free and based on completed transactions. Markets have started to be established around these interest rates.

Working groups have been formed in most countries to develop alternative reference rates. These working groups have made varying progress and the table below provides a summary of some of the development of alternative interest rates in the larger currency areas:

Common to all these countries is that they have used Libor as their key reference rate. It is highly likely that Libor will not be usable after 2021. In the eurozone, the Eonia reference rate will be replaced by Ester.

Work has begun in Australia, Canada, Norway, Denmark and many other countries, but they have not yet decided on an alternative reference rate. There are technical differences between the interest rates that have been developed so far. The main subject of discussion has been the fact that some are based on unsecured transactions and some are based on transactions on the repo market. The idea, however, is that they should all be based on transactions on liquid markets and all relate to interest rates with a term equivalent to overnight. The interest rates have been developed in working groups initiated by the central bank of each currency area and the major players on the markets have been involved in developing these interest rates.

There is still a lot of work to be done in these working groups in relation to conventions, how these rates are to be used and how the transition to the new interest rates will take place. In many countries, this involves developing tools to help market participants move from referring to Ibors to referring to the new interest rates. In countries where the use of Ibors will end, it is important to make clear what will happen to outstanding contracts that exist when the Ibor ends. This applies mainly to those countries where references have been made to Libor, which is highly likely to be discontinued at the end of 2021. Eonia is scheduled to end on 3 January 2022. New markets must also be developed for derivatives in those currency areas where new interest rates are being developed. Achieving liquidity in these new markets is also vital.

International development has so far been characterised by the markets, supervisory authorities and central banks working together in order to achieve the smoothest transition possible. It is necessary that outstanding contracts are not affected by the change, while a good level of liquidity must also be maintained in existing and future markets. All this is easier for larger markets, where there are many participants who can more easily provide liquidity in the markets where it is needed.

What has been done in Sweden?
Sweden has established a working group tasked with producing a recommendation for a virtually risk-free interest rate for the Swedish krona. The group aims to provide a recommendation for a new reference rate during the course of 2019.

In Sweden, the Swedish Bankers’ Association has initiated a working group that has been given the task of developing an alternative reference rate that should be as similar as possible to the alternative reference rates developed internationally. The Working group for alternative reference rates (AGAR) will develop an interest rate during 2019.

At the same time, the Swedish Bankers’ Association is working to have Stibor approved for use in financial contracts in accordance with the Benchmarks Regulation. This will mean that operators who conclude contracts in SEK and who need a reference interest rate in the contract do not have to rush the transition if it is undesirable for them to do so. It may therefore be the case that both Stibor and a new alternative reference rate co-exist in Sweden.

What is an interbank rate?
An interbank rate is the interest rate that banks use in transactions between one another.

The Swedish interbank rate, Stibor, indicates an average of the interest rates at which a number of banks – the Stibor banks – operating on the Swedish money market are willing to lend unsecured to one another for different terms. The average interest rate calculated is called a fixing. The corresponding interbank rate in Denmark is the Cibor and in Norway the Nibor. These fixings can be used as reference interest rates.

Interbank rates are usually available for different fixed-interest periods, from a single day up to a year. The shortest term in Sweden is one night but starting in 24 hours and is therefore called Tomorrow next (T/N) and the longest term is six months.

In Sweden, Stibor is expressed as the average interest rate at which banks are prepared to lend to other banks. This is not the case in every country. In some countries, the interbank rate refers to the average interest rate at which banks are willing to accept deposits from other banks.

What is a reference rate?
A reference rate is an interest rate used in a contract in which it is necessary to include some form of interest. A reference rate is used in contracts, for example, in order to have a neutral interest rate as a basis, which no party is able to influence.

Reference rates are mainly found in financial contracts where, for example, one party lends money to another party and wishes to receive interest on it. This interest rate can then be expressed as the reference rate plus or minus a certain number of basis points. Ibors are the most common types of reference rates but other interest rates are also used as reference rates. Stibor is a commonly used reference rate in financial contracts made in Swedish kronor.

How and when will the new reference rate be introduced?
The task of the Working group is to submit a recommendation of a nearly risk-free rate. The market participants must decide for themselves when they consider it appropriate to begin trading using the new interest rate.

The Working group for alternative reference rates intends to provide a recommendation in 2019 on the use of a new alternative reference rate. Another aim is that by the end of 2019, it should also be communicated which organisation can assume responsibility for the new reference rate and commit to its administration. Publication of the new reference rate is expected to begin in 2020.

Once a new reference rate is published, trading in financial instruments linked to the rate must begin in order to ensure that the interest rate is actually recognised as a new reference rate. For this to happen, there must be contract terms and trading venues in place for these instruments. It also requires sufficient confidence in the new interest rate for parties to have an interest in trading in instruments that refer to this interest rate.

With regard to outstanding contracts that refer to Stibor, no changes are necessary in relation to the new interest rate for as long as Stibor continues to exist. There may nevertheless be market reasons for making changes to the contracts, but this is entirely a matter for the contracting parties.

There is good reason to refer to the new interest rate or to use the new interest rate as a fallback for another reference rate in new contracts.

There is therefore no plan for any form of coordinated replacement of references to Stibor with references to the new interest rate. There are currently no plans to discontinue Stibor. It is more a question of all parties on the market making a commercial assessment of whether to conclude contracts using the new interest

Transition

Will Stibor be discontinued?
There are currently no plans and no requirement for Stibor to be discontinued in the same way as Libor and Eonia.

At this point in time, no decision has been made to discontinue Stibor. There is no desire or requirement from any authority, Swedish or foreign, for Stibor to end. Stibor and its administrator must nevertheless comply with the requirements stipulated in the Benchmarks Regulation ((EU) 2016/1011) and must be approved in accordance with the Regulation. As Stibor is considered a critical benchmark under the Benchmarks Regulation, an application for authorisation must be submitted before the end of 2021. The Swedish Bankers’ Association subsidiary Financial Benchmark Sweden AB is currently responsible for Stibor. An application will be submitted to the Swedish Financial Supervisory Authority in good time. The Swedish Financial Supervisory Authority will decide whether Stibor and its administrator are in compliance with the Benchmarks Regulation and whether the administrator can be authorised.

How will existing contracts with a reference to Stibor be affected by the introduction of a new reference rate?
Existing contracts with a reference to Stibor will not be affected by the introduction of a new reference rate.

At this point in time, no decision has been made to discontinue Stibor. Contracts with a reference to Stibor can continue for as long as Stibor exists. Once there is an alternative reference rate, there may be grounds to include a clause in the contracts stipulating that this rate will apply in the event that Stibor is discontinued (fallbacks). The Working group does not intend to advise on these issues. This must be a choice agreed between the contracting parties.

What is meant by fallbacks?
Fallbacks here refers to clauses in contracts that indicate what should happen if a benchmark is discontinued.

It may therefore be a clause stipulating that if Stibor ceases to exist, another specific reference rate should apply instead. The clause should describe how and why a change of reference rate should take place.

There has been a lot of focus internationally on the issue of fallbacks when the current reference rates are discontinued. This mainly concerns development in those countries that use Libor and which are highly unlikely to be able to refer to this rate after 2021. Two aspects of fallbacks are discussed more than others:

• Difference in credit risk and term: Ibors have an inherent credit risk as the interest rates include the credit risk that exists in the financial system. For example, Ibors rose sharply during the Lehman crisis and the European debt crisis. Such credit risk will not be as noticeable with a short term. If the new interest rate is based on repo transactions (USA and Switzerland), there is, in principle, no credit risk aspect at all in the interest rate. With a fallback from Libor to SOFR (RFR in the US), for example, the new interest rate should be lower because it does not include any credit risk. Interest rates for longer terms are usually higher than interest rates for shorter terms. The interest rate should therefore be lower if Libor 3 month is replaced with SOFR (O/N).
  
  In order to prevent any of the parties to the contract benefitting from a change of interest rate, the fallback solution should be as fair as possible and not lead to value transfers. An aspect should be introduced for credit risk adjustment and one for a change of term. It is very difficult to determine a future estimate for these aspects and historically they have often had varying outcomes, so there is great uncertainty about the most appropriate solution for these aspects.
• Triggers: If a financial contract containing a reference to an interest rate changes that interest rate, it is important that the conditions under which such a change of reference rate can take place are clear to all those involved. What should trigger a change? It has been suggested that this should be a statement by the supervisory authority, central bank or administrator. There have also been discussions about what the message should be: a statement that an interest rate is no longer suitable to include in financial contracts, that the interest rate is being discontinued, that the interest rate will be discontinued at a certain time or something else. It has also been suggested that it should be when an interest rate is no longer published in specific channels (Bloomberg, Reuters).

Global standards bodies, principally ISDA, have published suggestions for how fallbacks should be formulated. Other working groups for alternative interest rates, primarily the ARRC and the BoE’s working group, have also published recommendations for fallbacks.

Longer-term reference rates

What is the difference between Stibor 3m and the new reference rate?
The difference is that the new reference rate has a shorter term and lacks a credit risk element. Another difference is that movements in Stibor are influenced by the creditworthiness and liquidity of banks, while movements in the new interest rate are likely to be influenced primarily by monetary policy.

Most contracts that refer to Stibor use a fixed-interest period of three months. The new alternative reference rate, which the Working group is currently developing, will be an overnight rate.

The obvious difference between the interest rates will be that they have terms of different lengths. Another aspect is that Stibor indicates an average of the interest rates at which the Stibor banks are willing to lend to one another without security for different terms, while the new interest rate is based on actual completed transactions. These transactions relate solely to the banks’ borrowing transactions, so the new interest rate will be a borrowing rate, unlike Stibor, which is a lending rate.

Because the interest rates are based on different terms, financial contracts that refer to the respective interest rates will have different long-term interest periods. Those who currently have Stibor 3m know what interest rates will be paid or received over the next three months, while the fixed-interest period will be only one day when the new reference rate is used.

The new reference rate will be determined by actual completed transactions, unlike the current system, where transactions are not necessary.

It is also important to understand that the interest rates may be influenced by different factors. A short-term interest rate is affected by the monetary policy implemented to a much greater extent than a slightly longer-term interest rate. An Ibor is governed more by the situation in the banking system. Problems within the banking system could therefore lead to a higher Stibor, while not necessarily hitting short-term rates quite so hard. On the other hand, problems within the banking system may lead the central bank to consider there to be grounds for stimulating the economy (for several different reasons) and it may therefore lower its bank rate. A financial crisis can therefore lead to large differences between the two different types of interest rate. The opposite scenario can also lead to significant differences between the interest rates.

How have other countries dealt with the issue of longer-term reference rates?
Many countries have major problems obtaining a longer-term reference rate that is based on transactions on a liquid market. There are only few examples, therefore, of where new and relevant longer-term reference rates have been developed.

The issue of longer-term reference rates has been the subject of frequent discussion in many other countries. Particularly in those countries where the use of Libor is likely to be discontinued. The big question has been whether the financial system is able to cope with only an overnight rate if Ibors are no longer used.

In practically all countries, the answer has been no, although the reasons for this have varied. Nevertheless, most of them have been working to find a method for developing a transaction-based, longer-term reference rate that cannot be called into question or manipulated. The solutions that have been deemed most appropriate are those where the interest rate would be based on fixings made using the OIS market . These markets are not quite as developed or liquid, except in the United Kingdom. There has nevertheless been criticism that not even the UK’s OIS market has sufficient liquidity. The idea has been to develop a method of making fixings from the swaps made between the new RFR and longer fixed-interest periods.

There has also been criticism that a longer-term reference rate could lead to reduced interest in the new short-term reference rate (RFR). Why abandon one kind of fixed-interest period in Ibors if there is still a need for longer-term interest rates? This proposal may therefore represent a catch-22 situation. Developing a longer-term reference rate brings a risk of reduced use of the new RFR and as a direct consequence there is a danger that there will not be enough OIS transactions.

There have also been discussions about using the FRA or futures market as the basis for a longer-term reference rate.

Standards bodies and countries have agreed throughout that a longer-term reference rate is needed, principally for the loan market. At the same time, it has also been established that it will be very difficult to develop such an interest rate that is based on transactions on a liquid market. The very risk that a longer-term reference rate will reduce the need for a new short-term RFR has made some countries reluctant to even try to develop a longer-term reference rate. It has also been established that there is no reason to develop a longer-term reference rate that is not based on a sufficiently large number of transactions. This will gain nothing.

Will a longer-term reference rate be created in Sweden?
The Working group continues to work with and study international developments in the production of longer-term reference rates. As a longer-term interest rate would be based on transactions on a derivatives market that does not currently exist, it is important that these derivatives markets are made to work first.

At this point in time, no decision has been made to discontinue Stibor. The Working group is of the opinion that a new longer-term reference rate would only need to be developed if Stibor were to be discontinued. If such an interest rate is to be developed, it must also be based on transactions made on a liquid market. A longer-term reference rate would then also need to be adapted to the current regulatory framework for benchmarks, the Benchmarks Regulation.

Other countries have concluded that this could be handled by developing derivatives markets based on the new, short-term reference rate (the nearly risk-free rate, RFR). This has mainly involved standardised swaps based on the nearly risk-free rate, where the fixed portion of the contract has been used as the basis for a fixing. Basing a longer-term interest rate on transactions on the futures or FRA market has also been considered. No country has yet made this work, but the UK is at the forefront of development, as they have had a vital derivatives market for some time, which they can continue to work with.

There is nothing to suggest that Sweden would find it easier to develop a longer-term reference rate based on transactions on a liquid market than the much larger economies that are currently having difficulty with this method. There have been discussions about the fact that both Switzerland and the USA are currently having problems developing longer-term reference rates based on these derivatives markets. The Working group is of the opinion, however, that a longer-term reference rate is necessary in order to meet the needs of the Swedish market.

The Working group is currently focusing on developing a nearly risk-free reference rate (RFR, overnight). Once this interest rate has been established and derivatives trading based on this rate is taking place, the matter of developing a longer-term reference rate from these derivatives markets can be examined.

In those countries where there are no longer-term reference rates but where a nearly risk-free rate has been established, this has started being used in contracts. In order to create longer-term interest periods, certain techniques have been used to calculate these. The most common technique is to use compounded interest rates, or interest-on-interest rates. In this way, coupons can be created for three months or whatever convention dictates. This means, however, that the interest rate is calculated during the coupon period, which makes it impossible to know what the interest rate will be in advance. These interest rates are called backward-looking interest rates. Stibor is a forward-looking interest rate, where the parties know on entering into the contract what the interest rate will be during the coupon period. With a backward-looking interest rate, the parties only find out what the interest rate will be when the coupon is paid. These backward-looking coupons have so far been used for bonds and derivatives. They have not yet been seen on the loan market.

What happens if Sweden does not have the market conditions to produce a longer-term reference rate?
As long as Stibor remains, this rate can still be used. If Stibor is not retained, the alternative will be backward-looking compound interest rates.

The Working group hopes that Stibor will continue to be available for the foreseeable future. If Stibor were to cease to exist but a new virtually risk-free interest rate be established, the alternative will principally be some form of compound interest rates, in other words a backward-looking interest rate.

Internationally, the development of a longer-term, forward-looking interest rate that is based on transactions has been considered difficult. The working group in Switzerland has concluded that it is impossible to develop a longer-term, forward-looking interest rate. They have therefore aimed only to find solutions for the market that are based on a backward-looking interest rate. Switzerland therefore considers that it may be possible to do without forward-looking interest rates.

About AGAR (Working group for alternative reference rates)

Why was AGAR formed?
AGAR was formed to develop a nearly risk-free rate (RFR) for the Swedish krona.

This task was considered important because many other countries were developing this kind of interest rate. Short-term reference rates are incredibly important for all types of payments that take place internationally, as well as for financing and investments in other currencies, so Sweden cannot remain outside the global trend for using RFR. If contracting parties no longer wish to use derivatives, loans, investments or similar with a reference to Stibor, there must be an alternative comparable to those available in other countries.

Regulatory requirements for an alternative to existing reference rates in contracts have also provided justification for developing an RFR and a method for how to use it as an alternative.

Who are the members of AGAR?
The banks that currently produce Stibor (Danske Bank, Länsförsäkringar-bank, Nordea, SBAB, SEB, Handelsbanken and Swedbank). The Swedish Financial Supervisory Authority, the Swedish Central Bank, the Swedish National Debt Office and the Swedish Bankers' Association are also involved as observers.

In most other countries, the central bank has taken the initiative to develop an alternative reference rate. In Sweden, the Swedish Bankers’ Association took the initiative by establishing AGAR (the Working group for alternative reference rates). The members of the Working group are the banks that currently make a major contribution to Stibor, in other words Danske Bank, Länsförsäkringar-bank, Nordea, SBAB, SEB, Handelsbanken and Swedbank.

AGAR also includes representatives of the Swedish Financial Supervisory Authority, the Swedish National Debt Office and the Swedish Central Bank as observers. The Swedish Bankers’ Association administers the group and participates as an observer. The observers do not have voting rights in the group.

What is the objective of AGAR’s work?
The objective is to develop a nearly risk-free rate (RFR) for the Swedish krona and to provide a recommendation for this interest rate to the market.

Another objective is to examine whether there is a need to develop a longer-term reference rate. The RFR that is to be developed must be as similar as possible to the RFR of other countries.

How does AGAR maintain contact with the market?
Through consultations and various forms of dialogue.

As the work of AGAR is about developing a reference rate for market participants, it is important that all parties on the market understand the decisions that must be taken. AGAR therefore maintains a dialogue with the market through consultations and meetings. When AGAR reaches a decision-making point, the issue at hand will be sent out for consultation in order to obtain the market’s viewpoint. Comments received from the market will be published, including AGAR’s feedback and responses. The Working group’s decision will be published, including the reasons why a particular position has been adopted.

How does AGAR maintain contact with other working groups?
Contact takes place on an informal basis with the working groups of neighbouring countries.

There are working groups in most developed countries. AGAR maintains contact with working groups in Sweden’s neighbouring countries to see if there are opportunities for similar solutions. Contact is also maintained with the working groups of larger countries to the extent it is possible to learn about how they have acted in relation to certain problem areas. There is generally a strong desire in most countries, in particular the smaller ones, to find common solutions and so the working groups are open to cooperation.