The Financial Conduct Authority’s (“FCA“) announced that LIBOR the London Interbank Offered Rate, which serves as a gauge for the cost to lend money and set interest rates, would be phased out by the end of 2021. With two years to go, there are countless questions the financial world has yet to resolve.
What is LIBOR?
In the eighties, the financial world intended to create a universal measurement for interest rates between large, globally active banks. The British Bankers’ Association (“BBA“) launched what was referred to as the “BBA LIBOR” in 1986 and it quickly became an accepted industry standard. For more than 30 years, this has stood as the uniform calculation for the costs of unsecured loans from bank-to-bank.
LIBOR, by definition, is a calculation of five international currencies across different lengths of time, also known as maturities. Each business day, the Intercontinental Exchange publishes 35 different LIBOR rates. The most frequently quoted rate is the three-month U.S. dollar rate. This is considered to be the current LIBOR rate.
After the rigging scandals in 2012, the world learned the perilous potential for manipulation in the calculation of the LIBOR rate. Since then, there have been dramatic changes within the finance world, specifically in the calculation of interest rates, including methods that do not depend on LIBOR. Such changes resulted in LIBOR administration to be turned over to the ICE Benchmark Authority.
Despite the changes in the administration of LIBOR, many financial contracts still include LIBOR as an essential factor in determining loan costs.
What is happening to LIBOR?
As this year nears its end, LIBOR likely nears its own conclusion. The FCA substantially weakened LIBOR in 2017 when they announced that banks on the data reporting panel for LIBOR would neither ask nor require banks to submit their information within four years. This was a near deathblow to LIBOR because without that information, ICE cannot publish new rate calculations.
In the now infamous “Dear CEO” letter , the FCA advised major banks and insurers to begin preparations and actions to manage transition from LIBOR to alternative interest rate, in the “interests of financial stability and market integrity.” Furthermore, the letter cautioned that the transition would take time and the sooner these institutions ceased reliance on LIBOR the better. Reform seems to be a matter of when, not if.
What are the options for replacing LIBOR?
LIBOR was the standard for decades, but it was not the only standard, just the most common. There are other financial benchmarks such as the federal reserve funds rate and the yield on the 10-year treasury rate.
The currently proposed replacement in the U.S. is the Secured Overnight Financing Rate (“SOFR”). Different from LIBOR, SOFR is based on overnight repo transactions. The Alternative Reference Rate Committee of the Federal Reserve Bank of New York has been publishing this rate daily since April of last year. Chairman of the Alternative Reference Rates Committee, Tom Wipf, believes that “SOFR is the strongest alternative to LIBOR.” In his Wall Street Journal Op-Ed (Dec 26, 2019), Wipf states that ” SOFR is a resilient base for the hundreds of trillions of dollars in financial products that need to reference it.”
The financial world believes it could phase out LIBOR without a significant impact on the banking industry. We encourage all firms that currently rely on LIBOR to read and reflect on this letter. The continued participation and commitment of market participants to address the various challenges during this transition will be an essential part of the success of this collective effort. We stand ready to assist our clients with the transition.
For more than 100-years, SederLaw’s preeminent Banking & Finance practice group, one of the cornerstones of the Firm’s proud history, has provided superior counsel and legal representation to a broad and diverse client base of financial institutions, individuals, corporations and other business entities. Our Banking & Finance group, comprised of highly skilled attorneys with sophisticated knowledge and practical experience, has achieved a number of accolades and various regional and national rankings that have made SederLaw into the “go-to” law firm that is today for numerous banks, credit unions and trust companies; private equity funds, hedge funds and mezzanine financiers; conduit lenders; institutional and individual investors; mortgage companies; factoring companies, and trade credit, equipment and lease finance companies; and a wide array of other corporate borrowers and financiers.
Devon Kinnard, was recently named by U.S. News – Best Lawyers® (Banking & Finance) (Business Organizations). He practices in the Banking and Finance, and Business Law areas, focusing on commercial transactions, including bilateral and syndicated asset-based and commercial real estate loan facilities; private securities offerings and debt and equity capitalizations; joint ventures; mergers and acquisitions; and other corporate transactions arising out of the day-to-day operations of closely-held businesses. He serves as counsel to a number of financial institutions, including regional and national banks and credit unions, and private, mezzanine and other corporate financiers, in connection with both internal corporate and transactional-based matters. Mr. Kinnard assists lending clients in structuring and documenting large-scale, complex multi-tranche credit facilities, and as well smaller, more traditional commercial loan facilities, including those involving U.S. Small Business Administration (SBA) and quasi-governmental agency guarantees.
Contact:
Devon A. Kinnard
SederLaw
508-757-7721
