The London Interbank Offered Rate (LIBOR) has been the most widely used unsecured wholesale funding rate across the world since 1986. It has been used as a reference rate to price or hedge a host of financial instruments worth around USD 400 trillion across multiple jurisdictions.
In 2017, the UK’s Financial Conduct Authority (FCA) announced that LIBOR panel bank submission will become discretionary post 2021, which means the availability of LIBOR as a benchmark rate becomes completely uncertain. This will have a significant impact on the banking and financial services industry.
The discontinuance of the London Interbank Offered Rate will necessitate linking loans and derivatives segment to a new benchmark. Central banks around the world have been working to develop a replacement set of benchmarks based on what are called risk-free rates (RFRs)
There is a near consensus that the LIBOR will be replaced by U.S.’s Secured Overnight Financing Rate (SOFR) for all dollar loans, but other benchmarks like the U.K.’s Sterling Overnight Index Average (Sonia), and the Euro Short-Term Rate (ESTR)., are in the race as well.
Charles Yi, a partner at Arnold & Porter says “Every existing contract that references LIBOR will be impacted by the transition.”
Needless to say, that one of the major difficulties raised by the discontinuance of LIBOR is the sheer number of existing agreements that use LIBOR as an index, posing significant risks:
As regulators like the Financial Conduct Authority in the UK and the New York branch of the Federal Reserve in the US caution banks about the risks associated with LIBOR exposure, it would augur well for general counsel, asset managers, lenders, and everyone in between, to monitor the status of their LIBOR exposure.
A good starting point is to have information about the following key facets of the business that the Federal Reserve or the FCA is expected to ask:
A GC or an asset manager must gather all their commercial credit agreements and maintain a record of contracts reviewed, contracts with LIBOR clauses, and how many of those contracts have been fixed. But monitoring thousands of contracts is not an easy task especially when contracts that are tied to LIBOR may not necessarily mention “LIBOR”. Contracts could be using an interest rate term structure that is tied to LIBOR but does not explicitly contain the word “LIBOR” for instance it might have words and phrases like eurodollars, eurocurrency, and base rate, without mentioning “LIBOR”.
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White Paper, The End of the Road for LIBOR: Handling the Impact on the Financial World, Tata Consultancy Services
LexPredict, Blog: The ContraxSuite LIBOR Program