Introduction
This guide is designed to educate market participants, analysts, legal teams, and operations professionals on the transformation of global interest rate benchmarks—from legacy indices like LIBOR to modern, transaction-based Alternative Reference Rates (ARRs), including Risk-Free Rates (RFRs) and emerging Term Rates. We explore the historical context, rationale for reform, technical differences between rates, and the implications for financial contracts, systems, and market behavior.
I. Why LIBOR Was Abandoned
What LIBOR Represented
The London Interbank Offered Rate (LIBOR) was the foundational benchmark for pricing trillions of dollars in derivatives, corporate loans, structured products, mortgages, and more. However, LIBOR was a forward-looking, panel-based rate, derived not from actual market transactions, but from estimates submitted by major banks.
The Fall of LIBOR
- Manipulation Scandals: Banks were found to have manipulated LIBOR submissions to benefit trading positions.
- Lack of Underlying Transactions: Especially post-2008, interbank lending dried up, and LIBOR became increasingly speculative.
- Regulatory Reform: The Financial Conduct Authority (FCA) announced in 2017 that it would phase out LIBOR by the end of 2021 due to concerns about its integrity.
II. Rise of Alternative Reference Rates (ARRs)
Core Features of ARRs
- Based on Actual Transactions: Typically overnight and derived from real trades or repo markets.
- Risk-Free or Near Risk-Free: Reflect minimal credit risk.
- Transparent & Robust: Designed to be manipulation-resistant and liquid.
Key Examples of ARRs (Global View)
| Currency | Rate | Full Name | Type | Secured? | Administered By |
|---|---|---|---|---|---|
| USD | SOFR | Secured Overnight Financing Rate | RFR | ✅ Yes | NY Federal Reserve |
| GBP | SONIA | Sterling Overnight Index Average | RFR | ❌ No | Bank of England |
| EUR | €STR | Euro Short-Term Rate | RFR | ❌ No | European Central Bank |
| CHF | SARON | Swiss Average Rate Overnight | RFR | ✅ Yes | SIX Exchange |
| JPY | TONAR | Tokyo Overnight Average Rate | RFR | ❌ No | Bank of Japan |
| CAD | CORRA | Canadian Overnight Repo Rate Average | RFR | ✅ Yes | Bank of Canada |
| SGD | SORA | Singapore Overnight Rate Average | RFR | ❌ No | Monetary Authority of Singapore |
| HKD | HONIA | Hong Kong Dollar Overnight Index Average | RFR | ❌ No | Treasury Markets Association |
| AUD | AONIA | AUD Overnight Index Average | RFR | ❌ No | Reserve Bank of Australia |
| CNY | CHIBOR, LPR | China Interbank Offered Rate / Loan Prime Rate | Not true RFRs | ❌ No | PBoC / National Interbank Funding Center |
| INR | MIBOR | Mumbai Interbank Offered Rate | Panel-based | ❌ No | Financial Benchmarks India |
III. Not All Rates Were Replaced: EURIBOR, NIBOR, TIBOR
While LIBOR was discontinued, other IBOR-type rates still exist or have been reformed rather than retired:
- EURIBOR (Euro Interbank Offered Rate): Remains in use, but reformed to include a hybrid methodology combining actual transactions with expert judgment.
- NIBOR (Norwegian Interbank Offered Rate): Still in use, though discussions around reforms or transitions to NOIS (Norwegian Overnight Indexed Swap) exist.
- TIBOR (Tokyo Interbank Offered Rate): Coexists with TONAR in Japan. A reform roadmap is in progress.
- HIBOR (Hong Kong Interbank Offered Rate): Still used alongside HONIA.
These rates persist due to:
- Unique regional lending behaviors.
- Lack of deep underlying markets for overnight secured/unsecured trades.
- Political or structural resistance to change.
IV. What Are Risk-Free Rates (RFRs)?
Definition
RFRs are nearly risk-free, short-term interest rates that reflect the cost of overnight borrowing—either secured (e.g., repo-backed) or unsecured. They are published daily and designed to replace LIBOR and similar rates.
Attributes of RFRs
- High Volume: Derived from large pools of data, making them statistically robust.
- Low Credit Risk: Unlike LIBOR, they don’t include credit premiums for bank risk.
- Overnight Tenor: Not inherently forward-looking (i.e., do not offer 1-month, 3-month structures like LIBOR).
V. The Emergence of TERM Rates
Why Term Rates Are Needed
While RFRs are technically sound, many business loans, commercial real estate loans, and retail products require a forward-looking rate to:
- Price loans ahead of the interest period.
- Provide operational predictability.
- Align with traditional accrual/accounting practices.
Types of Term Rates
| Term Rate | Base | Published By | Currency |
|---|---|---|---|
| Term SOFR | SOFR Futures | CME Group | USD |
| Term CORRA | CORRA Futures | CanDeal Benchmark | CAD |
| Term SONIA | SONIA Swap Market | Refinitiv | GBP |
| Term SARON | SARON Compounding | SIX Exchange | CHF |
| Term €STR | Limited use; under development | European Central Bank (ECB) | EUR |
🔎 Note: Term Rates are NOT true RFRs but derivatives or projections based on them.
Use Cases
- Business loans
- Trade finance
- Securitizations
- Retail mortgages (in some jurisdictions)
Limitations
- Not for Derivatives: Regulatory guidance discourages their use in most swaps and capital market hedges.
- Licensing & Fees: Many TERM rates require commercial licenses and fees.
VI. Free vs. Paid Access & Oversight
Free Access
- Central banks (e.g., Fed, ECB) publish base RFRs freely.
- These are often embedded into daily system rates via APIs.
Commercialized / Paid Access
- Term rates, custom curves, or vendor-supplied versions (e.g., Bloomberg BSBY, ICE Bank Yield Index) may be subject to commercial licensing.
Governance Structures
- U.S.: ARRC (Alternative Reference Rates Committee)
- While at SS&C Advent Software when I working leading the Geneva product, I worked closely with the ARRC to help establish, agree and build ARR systemetic support when LIBOR was succeeding.
- U.K.: SONIA Oversight Committee
- EU: Working Group on Euro Risk-Free Rates
- Multilateral: Financial Stability Board (FSB), IOSCO benchmark principles
Oversight includes:
- Ensuring benchmark compliance.
- Publishing fallback frameworks.
- Supporting international coordination and transition timelines.
VII. Market Impacts and Operational Implications
Fallback Language & Contract Reform
Legacy LIBOR contracts were required to implement fallback triggers, often referencing:
- A switch to compounded RFRs.
- Predefined spread adjustments.
- Replacement indices chosen by agents or central banks.
System Complexity
- ARR-based products require changes to:
- Payment frequency and timing
- Interest accrual logic
- Loan servicing and reporting
- Systems must support:
- Lookback periods (e.g., 5-day lag)
- Compounding conventions (daily vs. simple)
- Waterfall fallback logic
VIII. Summary: What You Need to Know
| Topic | LIBOR | ARR / RFR | TERM Rate |
|---|---|---|---|
| Forward-Looking | ✅ Yes | ❌ No | ✅ Yes |
| Based on Transactions | ❌ No | ✅ Yes | ✅ Derived |
| Includes Bank Credit Risk | ✅ Yes | ❌ No | ❌ No |
| Global Alignment | ✅ Yes | ✅ Yes | ⚠️ Partial |
| Licensing Required | ❌ Often Free | ✅ Often Free | ✅ Often Paid |
| Regulatory Preference | Deprecated | ✅ Strongly Preferred | ⚠️ Specific Use Only |
Conclusion
The move from LIBOR to transaction-based Alternative Reference Rates represents one of the most significant financial reforms of the 21st century. Though Risk-Free Rates improve transparency and accuracy, the transition introduced substantial operational, legal, and technological challenges.
Financial institutions, vendors, and borrowers must now operate in a multi-rate, multi-tenor world—balancing legacy IBORs like EURIBOR with new structures like Term SOFR or compounded SOFR-in-arrears. Success in this new era demands systems that are flexible, adaptive, and globally aware.
This guide as a part 2: https://gagegorman.com/understanding-arrs-rfrs-with-calculation-examples-system-implementation-part-2-of-2/
Cheers,
Gage Gorman
www.gagegorman.com