Today the London Interbank Offered Rate (LIBOR) is still among the most commonly used interest rate benchmarks. However, LIBOR will cease to be available from the end of 2021. All users of LIBOR – both lenders and borrowers – will need to be prepared for this discontinuation.
Background
In July 2019, the FCA announced that banks will no longer have to provide quotes for the purpose of calculating LIBOR from the end of 2021, and there will be a transition from LIBOR (and other interbank offered rates) to alternative forms of reference rates known as near Risk-Free Rates (RFRs). This transition will constitute a fundamental change to the way banks and financial institutions operate. Commercial borrowers will also be affected if, for example, they are party to loan agreements set to run beyond 31 December 2021 which use LIBOR to calculate the interest rate, or they have hedging arrangements or other commercial contracts in place which use LIBOR as a reference rate for determining payment obligations.
Replacing LIBOR
Each LIBOR currency (currently LIBOR rates are available for sterling, US dollar, Euro, Swiss Franc and Japanese Yen) will be replaced with a different alternative reference rate. These new RFRs have been developed separately (with some coordination) and each rate is produced on a different basis. This gives rise to a number of potential issues and challenges. For example, the new RFRs are developing differently in different jurisdictions, there may be issues with consistency across the benchmarks and this could give rise to arbitrage opportunities or a competitive advantage of some markets over others. In addition, some rates are unsecured whereas others are secured. This means that the different types of rates are likely to respond differently in times of crisis or when a recession hits.
Next Steps
Anecdotal evidence suggests that levels of preparedness for the transition away from LIBOR differ widely across the market. To ensure that businesses are prepared for the changes resulting from the transition away from LIBOR, we would recommend various steps to identify and analyse exposure to LIBOR abolition. From there, businesses should analyse this exposure, prepare a plan for addressing it and implement this plan well before the end of 2021.
Identification of an entity’s exposure to LIBOR abolition involves various matters, including the following:
- A review of current funding documents.
- A review of interest rate hedging arrangements
- A review of other commercial contracts which may also make use of LIBOR; and
- Where appropriate, a consideration of whether assets held within a pension fund involve any form of link to LIBOR.
Once the areas of potential exposure have been identified, it would be possible to formulate a strategy – e.g., by determining an approach to appropriate substitute rates and approaching relevant counterparties to negotiate appropriate contract amendments. Fladgate are well position to assist you with developing that strategy.
