January 04, 2019
In 2017, the UK’s Financial Conduct Authority announced that as of 2021 it will no longer look to banks to supply Interbank borrowing rates which contribute to the calculation and publishing of LIBOR. This does not necessarily mean LIBOR will stop being published, however it does give a strong indication it is nearing its end of life, and that end of life poses a number of questions for treasurers. What is the expected path forward if LIBOR stops being published? How will older contracts which reference LIBOR continue? What are the ramifications to business while these changes are being made?
There are two general paths for moving forward. In the first, LIBOR continues to be supported and published. Given the scale of the market and the slow pace of the changes so far this may be the most likely option, at least in the short term. The second path is a complete replacement of each currency LIBOR currently published. Where a replacement is used, a renegotiation of every contract would be required. What many expect to see is an increased usage of alternatives, with adjustments applied to mimic LIBOR and accommodate differences in risk profiles of each reference rate.
There are already a number of replacements being proposed for all currencies which have continued to publish LIBOR rates. In many cases these rates are an attempt at a risk-free rate and most are current overnight terms only. The risk-free replacements are typically based on market trading data, usually related to interbank repo trades. For example, the Alternate Rate Reference Committee has come up with the Secured Overnight Financing Rate (SOFR) as the USD alternative to LIBOR. This rate which is based on interbank repo trades is overnight terms only. This gap in risk profile and terms presents significant issues in replacing LIBOR.
For any buy side corporates with deals referencing LIBOR, the change may have a significant impact. Corporates should expect deals may need renegotiation. Pricing and risk also need to be re-evaluated. Accommodating a simple renegotiation requires an understanding of how LIBOR compares to any new index, what risk differences arise, and how that may impact any new deal.
A summary of how a LIBOR change will impact corporates is summarized below: