LIBOR’s swan song


While some companies have started or completed transitions and others have clear plans to do so, there are others who have yet to begin their preparations. Now is the time to engage with their financial institutions to ensure a smooth transition.

LIBOR currently backs more than $ 400 trillion in loans, bonds, derivatives and other financial instruments. But doubts have arisen in the aftermath of the global financial crisis over the integrity and reliability of LIBOR after the emergence of cases of market manipulation. Although the first public exhibition was in 2012, there is evidence that the benchmark game dates back almost a decade.

A 2014 study by the Financial Stability Board (FSB) on the reliability and robustness of interbank benchmarks recommended the development of alternative benchmarks, with a preference for the use of near risk-free rates (RFR).

A major problem with LIBOR was that it did not reflect actual transactions but rather a panel of banks’ estimates of a hypothetical rate they would expect to pay at some point.

National working groups have been set up in each country to identify and develop strategies for the transition to these RFRs. Meanwhile, the UK’s Financial Conduct Authority (FCA), which oversees the administrator of LIBOR, concluded that LIBOR was not viable. The FCA announcement in 2017, it would no longer require panel banks to submit LIBOR estimates after December 2021, effectively giving LIBOR an expiration date.

In December 2020, a consultation by the administrator of LIBOR was announced to examine whether the US dollar LIBOR would continue until June 2023, while the currencies other than the US dollar, namely the Japanese yen, the euro, the British pound and the franc Switzerland, would cease on December 31, 2021. On March 5, the termination announcement from the ICE Benchmark Administration and the FCA effectively locked LIBOR end dates and started ticking the deadline.

Industry recommendations

The transition from one state of operation to another always involves uncertainty and some risk – and the transition away from LIBOR is no exception. With task forces and regulators in each jurisdiction making decisions and recommendations that apply to benchmark rates for their currency, coupled with how the new rates will be used in different financial products, the transition away from LIBOR would go. always be complex.

Through extensive industry consultation by national working groups (such as ARRC, UKRFRWG and SC-STS) and industry bodies (such as ISDA, LMA, LSTA and APLMA) the preferred or recommended approaches have evolved in recent years. These recommendations are just that, however. They guide the industry on likely approaches to the transition and conventions for using RFRs.

The derivatives market through ISDA has evolved to provide the safety net of robust fallback solutions through the ISDA IBOR supplement on fallback solutions and associated protocol. In loan markets, it is only in recent months that transitions have truly started and industry conventions have become more commonly accepted and adopted by most parties.

Each lender should provide borrowers with details of their proposed alternatives and be able to explain how the transition away from LIBOR is fair for both parties, as required by global regulators.

Key considerations

In an RFR environment, each additional currency adds complexity to documenting cash product transactions. As such, borrowers should carefully consider the currencies in which they want or need to have financing available.

For some borrowers who previously had “multi” or “all currencies” on loan documents, a simple solution might be to remove some or all of the LIBOR currencies.

Borrowers who still wish to access financing in US dollars but not in other LIBOR currencies could postpone the transition of their lending facilities until 2022 by eliminating the other currencies or restricting their ability to draw in these currencies.

Borrowers could then continue to finance under existing facilities referencing US dollar LIBOR and transition when market covenants in the US dollar market are more settled. U.S. regulators have recommended that no new U.S. dollar LIBOR products be entered into after the end of 2021, with some exceptions for derivatives used for risk management.

Those who finance or invest in LIBOR-referenced treasury products and use derivatives to hedge their exposures should pay particular attention to the market conventions evolving in the various RFR products in order to avoid any unnecessary basis risk.

Reservation, risk, operating and financing systems will likely need to be changed to accommodate the new benchmark rates, fallback rates and calculation methods. Such changes often require project management and due diligence and have a significant lead time.

Affected companies should also identify all the accounting, tax and legal implications of the transition and take action to manage these risks.

RFR terms

At the end of July 2021, the ARRC approved the CME SOFR term rate, removing one of the last major hurdles in global markets to make the transition. This move will make it easier for borrowers with US dollar debts to move away from LIBOR. A forward rate is more like LIBOR, providing more certainty over cash flow and requiring fewer system changes than compound RFRs.

Another SOFR term was recommended by ARRC for use in US dollar commercial loans and multi-lender facilities. This differs from the FCA in the UK which has limited use case for Term SONIA in sterling denominated products for trade finance, emerging markets and the retail market. SONIA term is not available for business loans.

The Bank of Japan has approved the TORF as the forward rate in Japan without any use case restrictions. There is no RFR term available for Swiss Franc and Euro products, although the Euribor continues to be published and fulfills this role for the Euro market.

The industry is studying the implications of the different use cases of forward tariffs and is preparing for a more widespread use of the term SOFR. The differences in the approach to forward rates between USD, GBP and JPY will make multi-currency products more complex. A careful analysis of your specific currency needs should be carried out as a priority

Avoid rush

The length of time it took for the industry to choose preferred substitutes left a relatively short period for borrowers and lenders to move their old products and transactions away from LIBOR.

While best efforts are being made to manage the expected industry workload, companies should act now, engage with their counterparts, make the necessary preparations, and seek to avoid being dragged into the rush to get out of business. LIBOR.

Duncan Marshall is LIBOR-Business Transition Manager and David Doyle is LIBOR-Communications Transition Manager at ANZ Institutional

This article originally appeared on ANZ Institutional website


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