Guest Commentary
By Christopher Rockers, Nicholas Kenney and Ani Kaufmann Mamisashvili, Husch Blackwell
Preparing for the LIBOR Transition:
The use of LIBOR is drawing to an end. For decades, financial institutions have used LIBOR (the London Interbank Offered Rate) as the prevailing reference rate for determining interest rates in commercial and financial transactions. As a response to the manipulation of LIBOR almost a decade ago, the United Kingdom’s Financial Conduct Authority announced in 2017 it did not expect LIBOR to remain as an acceptable benchmark for floating interest rates beyond 2021.
Although the LIBOR transition is still in process, there are some settled ways to deal with the transition and trends in the replacement rate for LIBOR. Preparing now for this transition is important.
I. Current State of LIBOR
LIBOR is calculated from estimates submitted by a panel of leading London banks. Today, commercial contracts totaling nearly $200 trillion use LIBOR as a “benchmark.”
On March 5, 2021, Intercontinental Exchange and the FCA confirmed that LIBOR will phase out by June 30, 2023, and one-week and two-month LIBOR will cease being published by Dec. 31, 2021. On March 9, 2021, the Alternative Reference Rate Committee confirmed that ICE’s announcement of a definitive cessation date for LIBOR tenors constituted a “Benchmark Transition Event,” which began the process of switching from LIBOR. However, this “Benchmark Transition Event” does not require an immediate transition.
II. How to Transition to a New Reference Rate
New contracts executed before Dec. 31, 2021, should use a non-LIBOR reference rate or have robust fallback language, including a clearly defined alternative reference rate to replace LIBOR. Te ARRC, a group of private-market participants convened by the Federal Reserve, has proposed using the Secured Overnight Financing Rate to replace LIBOR.
SOFR is a risk-free, daily, overnight rate and based on actual interbank transactions with daily volumes approaching $1 trillion. SOFR is calculated daily and can be simple (Daily Simple SOFR) or compounded (Daily Compounded SOFR). Because LIBOR is a credit-sensitive rate and SOFR is a risk- free rate, there are established spread adjustments to cause SOFR based rates to align with LIBOR. SOFR also can be calculated for forward-looking tenors and published by an authorized benchmark administrator. Such forward-looking SOFR is referred to as Term SOFR.
Daily Simple SOFR and Daily Compounded SOFR are similar, so the ARRC recommends the use of Daily Simple SOFR to keep calculations simpler. We have seen at least one market participant in a new contract use Daily Simple SOFR as the reference rate, with fallback language to Term SOFR once it is established or a different rate that becomes more appropriate. Some lenders also have discussed using other reference rates, which may be credit-sensitive rates such as a rate called AMERIBOR. To date, comparable credit-sensitive rates do not appear to have much of a following, and we have seen only isolated instances where such reference rates have been used.
20
mobankers.com
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32
