BY Deborah Carmichael
Will the end of (L)IBOR be delayed?
Many banks and other financial services businesses and corporates have started preparing for life after the London Interbank Offered Rate (“LIBOR”). We are now less than two years away from the LIBOR and other Interbank Offered Rates (“IBORs”) being discontinued. Global banks are only required to submit LIBOR until the end of 2021.
The proposal is to replace LIBOR and other IBORs with (nearly) risk-free rates (“RFR”) in certain major jurisdictions. Transitioning from IBORs to RFRs will cause a seismic shift in the financial markets and this transition is arguably the biggest technical challenge facing the financial markets today. For some perspective, LIBOR has earned the right to be called the world’s most important rate. In 2018 alone, LIBOR-based transaction underpinned nearly USD200-trillion in outstanding volumes of USD LIBOR contracts.
IBORs are interest rates at which banks can borrow money in the interbank market on an unsecured basis from overnight to 12 months. The most widely used IBOR and the one that most people will be familiar with is LIBOR, which is the IBOR for the London Interbank Market and is quoted in GBP, USD, EUR, Swiss Franc (CHF) and Japanese Yen (JPY). The three-month LIBOR maturity, followed by the six-month LIBOR maturity, are the most widely referenced rates in all currencies by volume.
There has been a significant decline in the interbank unsecured funding markets in the last decade (plus a few years). Much of the decline can be attributed to changes in the regulatory framework applicable to banks which made it difficult for banks to borrow money in the short term unsecured markets and still satisfy global liquidity rules. For example, the Basel Committee on Banking Supervision’s liquidity rules, such as the Liquidity Cover Ratio and Net Stable Funding Ratio, require banks to be funded by long-term debt (rather than short-term debt). Since there is limited activity in the unsecured interbank market, the submissions from panel banks are no longer based on actual transactions and are based rather on expert judgement.
A search for replacement IBORs began in earnest in 2014 through a number of regulator-led working groups in most major jurisdictions. In the US, the Alternative Reference Rate Committee (ARRC) led by the US Federal Reserve selected the Secured Overnight Funding Rate (SOFR) as the replacement rate for USD LIBOR in 2018. In the UK, the Sterling Overnight Index Average (SONIA), which was a pre-existing rate, was made more robust by increasing the underlying volumes of transactions to set the rate. These regulator-led working groups are at various stages of the paced transition.
Industry rightly asked whether the end of LIBOR would be postponed given the world pandemic currently taking centre stage where important decision making is concerned. The answer is currently no. On Friday, 27 March 2020, the Financial Conduct Authority (“FCA”) in the UK published a statement to the effect that, despite the current market disruption being caused by the coronavirus, the central assumption remains that firms cannot rely on LIBOR being published after the end of 2021. However, the FCA has acknowledged that interim milestones may be impacted (particularly in the loan market).
Although we expect there to be further updates, our advice is not to let this slip through the cracks. Firms need to adopt a formal transition programme across affected business units. We have identified the following IBOR programme priorities:
- IBOR contract inventory and exposure assessment;
- review of contractual terms to determine fallbacks if LIBOR or another IBOR is temporarily or permanently discontinued;
- prepare to renegotiate impacted contracts if necessary;
- consider reducing IBOR exposures by transitioning to RFR products;
- investment to infrastructure (including technology and data systems may be needed);
- treasury processes considerations including, tax, accounting and corporate treasury issues such as transfer pricing; and
- customer communication.
Contact us for updates, developments and recommendations regarding your IBOR transition. Our tax and banking and finance teams are well placed to assist you with your transition requirements.
Banking and Finance | Director
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