02 October 2019
It has been two years since the Financial Conduct Authority (UK) (FCA) announced that the London Interbank Offered Rate (LIBOR) will cease in 2021.
As this deadline nears, and the FCA continues to stress the assumption that there will be no LIBOR publication after end-2021, regulators and industry bodies around the world are urging market participants to prepare for the transition with increasing intensity.
FCA’s Chief Executive, Andrew Bailey, recently commented that firms delaying transition are making a mistake. The CEO of the Asia Pacific Loan Market Association (APLMA) has also stressed that “time is now of the essence” and that members need to be informed of the upcoming “seismic changes”.
In Australia, the Australian Securities and Investments Commission (ASIC) has written to major financial institutions imploring them to undertake a comprehensive risk assessment in respect of their exposure to LIBOR.
Working groups in different jurisdictions have now each identified an overnight risk-free rate (RFR) for their currency.
Each RFR is at different stage of development, as highlighted in the table below. Unlike LIBOR, the RFR is only an overnight rate, which is available in various term lengths. The RFR, anchored in active and liquid market transactions, is inherently risk-free and so lower than LIBOR (which accommodates credit and term risks).
Due to the difficulty in reconciling the differences between RFRs and LIBOR, the loan market lags behind other financial markets in its transition to RFRs.
As RFR is only an overnight rate, interest amounts are determined at the end of any given interest period. This is troubling for both lenders and borrowers for cash flow management purposes.
There is a push for development of forward-looking term interest rates based on the RFR, using derivative transactions that reference RFR, provided that there is sufficient liquidity. SONIA is the most advanced in developing the Term Sonia Reference Rate.
There is substantial uncertainty regarding the viability and timeline for RFR term rates. Transition is not just about new business, but also about converting legacy LIBOR contracts. Regulators are stressing that RFR term rates will not be the primary avenue for transition, and are urging market participants to proceed with their transition plans to RFR without waiting for RFR term rates to become available.
Loan documents often do not exist in isolation, and simultaneously with amending the rate applicable to the loan, any hedging transaction must also be amended or alternatively terminated (which may trigger break costs) and fresh hedges entered into.
As LIBOR is used in a broad range of commercial (i.e. non-financial) contracts, those contracts must be amended.
Market participants are well advised to consider referencing RFRs for new contracts, identify any contracts that include LIBOR clauses, evaluate their position and prepare for negotiating amendments to documents. For complex cross-border transactions, negotiations may be more protracted than expected, and the clock is ticking.
The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.