LIBOR Transition Update – The end of an era

Posted: 16/02/2022

For more than 40 years, the London Interbank Offered Rate (LIBOR) was the key benchmark for interest rates around the world. But after years of pushing for reforms, and the various criminal prosecutions resulting from the rate-rigging scandal, LIBOR’s days were numbered.

The countdown clock has been ticking away over the last few years and the doomsday date has now arrived; LIBOR is no more (for the most part, at least). So what has changed, what new rates are in operation, and what are the next steps for banks and borrowers to take in the post-LIBOR era?

What’s changed?

Right from the first announcement of the cessation of LIBOR in March 2021, through the cessation date of 31 December 2021 to today, we have seen firms work tirelessly to move away from the use of existing LIBOR rates toward the use of alternative risk-free rates (RFRs). Initially, where it was not possible to exclude LIBOR, lenders would incorporate fallback and rate switch provisions to allow for the transition to new reference rates. However, this option was not going to be available indefinitely, and we have now jumped that 31 December hurdle.

Since the milestone date, we have now seen an end to all euro and Swiss franc settings, as well as the overnight, one-week, two-month, and 12-month Japanese yen settings, and welcomed the use of RFRs.

Sterling

It looks like sterling markets are off to a good start having generally navigated the transition on time and with minimal disruption, according to the Bank of England’s joint release. The Working Group’s preferred benchmark Sterling Risk-Free Reference Rate is the Sterling Overnight Index Average (SONIA), although the Base Rate remains available.

SONIA will commonly appear compounded in arrears, while Term SONIA will be used when forward-looking rates are needed, mainly in trade finance.

USD

In the USA, the Federal Reserve’s Alternative Reference Rates Committee (ARRC) formally endorsed the Secured Overnight Financing Rate (SOFR) as the preferred replacement for all tenors of USD LIBOR. For most products, this will take the form of SOFR compounded daily in arrears. However, as is the case for SONIA, alternative, forward-looking options are available where appropriate, and the Term SOFR tenors published by CME Group are already seeing use.

Unlike for the other currencies, some tenors of USD LIBOR are expected to be continually published until 2023, but the authorities on both sides of the Atlantic have made it clear that such rates are available purely to assist with the transition of legacy contracts, and that any new use of USD LIBOR is no longer permitted; see the FCA’s prohibition notice for further detail of the position in the UK.

“New use”

What constitutes “new use” for this purpose, however, is not entirely clear. Questions have been raised as to whether new drawdowns under uncommitted facilities entered into prior to 1 January 2022 would result in lenders having new exposure to LIBOR.

Pending any clarification from the FCA in this regard, lenders would be advised to consider their internal policies and procedures set out by their LIBOR transition committees and/or compliance teams. In any event, any such LIBOR-referencing contracts should be the focus of active transition to risk-free rates, in accordance with the relevant fallback provisions contained therein. If in doubt in relation to a specific contract, it would be worth consulting with the regulators and seeking appropriate advice before committing to lending funds.

Practical steps

With use of the new risk-free rates increasing daily, all lenders should now be focusing on ensuring the active transition of legacy contracts and avoiding any new use of LIBOR.

Firms should urgently ensure operational capability to use new rates, including but not limited to checking any applicable licensing requirements for accessing and using such rates. It would also be beneficial for compliance teams to ensure their commercial colleagues are sufficiently briefed regarding the new rates and policies.

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