LIBOR End Dates Confirmed
The end date for LIBOR is now certain. On March 5, 2021, the UK Financial Conduct Authority (FCA), which oversees the global benchmarks, confirmed that most LIBOR tenors will cease on December 31, 2021. This cessation announcement includes the LIBOR benchmarks in gbp, euro, Japanese yen, Swiss franc and certain of the US dollar benchmarks. Five US dollar LIBOR benchmark tenors will survive until June 30, 2023. These include overnight, one-, three-, six- and twelve-month USD LIBOR.
The announcement is the final chapter in LIBOR’s long goodbye that began in 2017 in response to the decade-old manipulation scandals that plagued the benchmark. Since that time LIBOR liquidity has also dried up so that it was no longer the representative rate it once was. LIBOR underpins over $200 trillion in financing transactions including derivatives, floating-rate notes, securitisations, mortgages and credit cards. On March 9th, the Alternative Reference Rates Committee (ARRC) confirmed that the LIBOR cessation announcement constitutes a “Benchmark Transition Event'' for all USD LIBOR tenors, thereby triggering fallback provisions in a variety of products, with ARRC issuing a statement and FAQ’s Regarding the Occurrence of a Benchmark Transition Event.
What are the regulators saying about the end of LIBOR?
The banking regulators have long been urging institutions to be prepared to move away from reliance on LIBOR and make the switch to the risk-free replacement rates (RFRs). This is no simple apples-to-apples switch. RFRs, such as Secured Overnight Financing Rate (SOFR) in the United States and Sterling Overnight Index Average (SONIA) in the UK have different characteristics than LIBOR, the most fundamental of which is that LIBOR is forward looking whereas most RFRs are backward looking. The shift away from LIBOR requires an overhaul to IT systems including third party systems, repapering and renegotiation of affected contracts that span virtually all lines of business within the institution, and outreach and communication to impacted counterparties. Most major global banks have been working diligently in anticipation of LIBOR cessation, many having dedicated LIBOR Transition Offices and structured governance overseeing the transition away from LIBOR.
The banking regulators, including the Federal Reserve, have stepped up the emphasis on the need to be prepared and have stated that they will be looking for progress. As a safety and soundness concern, the Federal Reserve could issue MRAs (Matters Requiring Attention) to institutions that are not sufficiently prepared. The OCC recently issued a self-assessment tool for banks to use to evaluate their preparedness. Banks need to identify and mitigate the risk of transitioning away from LIBOR.
Significantly, there should be no new USD LIBOR contracts, regardless of tenor, after the end of 2021.
Why is there a later date for the cessation of certain USD LIBOR benchmarks?
The primary reason for the extension for certain USD LIBOR tenors is that more bonds and loans are tied to USD LIBOR than any other currency. Known as “tough legacy contracts”, these contracts do not include viable fallback provisions to convert to a non-LIBOR rate and are virtually impossible to amend due to unanimous approval requirements for any amendment to change the rate. The extension timeframe will allow most of these tough legacy contracts to mature on their own terms. Still, some tough legacy contracts will remain after 2023.
Legislation to address tough legacy contracts has been proposed at both the federal level and in New York, the law under which the majority of affected contracts are governed. As proposed, such legislation provides that the rate would switch to a benchmark rate based upon SOFR and provide a litigation safe harbour. In the UK, the regulators are considering a synthetic LIBOR calculation to address tough legacy contracts.
My company is not a financial institution, so I do not need to worry, right?
Non-financial entities face LIBOR exposure as well. The exposure includes both intercompany transactions that have LIBOR exposure as well as transactions with financial institutions. For intercompany loans, corporations will need to determine the extent of their exposure and develop a strategy to amend or repaper those contracts to reflect appropriate benchmarks. Depending on the complexity of the company’s financing, this task may present a significant challenge since many entities do not have line of sight into their contracts. Generally, this type of review and adjustment of contract terms should be handled at an arm’s-length basis. The outcomes need to be documented and in line with market behavior. Additionally, entities with impacted LIBOR based financing would be wise to take steps to understand their various positions rather than waiting for the financial institution to reach out for next steps in the transition away from LIBOR.
What are the best steps to take now to ensure a successful transition away from LIBOR?
Despite its many challenges, the past year enabled many corporate entities and financial institutions alike to envision a more holistic digital transformation. Even with the light at the end of the pandemic tunnel, we will not go back to the old ways of doing things. It is time to embrace and invest in technology to avoid being left behind. Leveraging technology such as artificial intelligence and contract lifecycle management systems will enable a smoother transition away from LIBOR and provide the essential steppingstone in the digital transformation journey. The DocuSign Agreement Cloud offers solutions for complex matters such as LIBOR transition, data privacy regulatory changes and vendor contracting risk review and reduction.
Guest author: Lynn Sumlin, director Agreement Cloud strategy