The London Interbank Offered Rate (LIBOR) is being replaced from 31 December 2021, ending a universal rate that has long been applied across the world. In its place, different jurisdictions will set their own rates.
The UK will move to the Reformed Sterling Overnight Index Average (SONIA), the US will set the Secured Overnight Financing Rate (SOFR) and the European Union will move to the Euro Short-Term Rate (€STR). In other regions, respective rates will be set by their own administrators.
LIBOR has been widely used since the 1980s to set interest rates on loans, loan notes, leasing, financial and commercial contracts, valuations, intra-bank borrowing, and much more. It has been used as a benchmark for over $350 trillion worth of financial contracts, so a move away from LIBOR will have significant consequences on IT, legal, risk, management and financial reporting.
Yet many businesses are not aware of this change or have not started planning for its impact. Even today, contracts are still using LIBOR as a measure with no transition clauses in place.
If you haven’t started preparing for the end of LIBOR, here are the legal, transfer pricing and financial reporting questions you need to ask:
- Which rate do I use going forward on financial contracts? For global organisations, do I use the European rate or the US rate? Or both of them?
- Will the rate to be used be governed by the country or region of jurisdiction or the currency being used?
- What do I do about contracts and agreements that already use LIBOR? Do I need to redraw them?
- What is the impact on my transfer pricing arrangements? What do I need to do consider and what are the risks if I do nothing?
- How will the change in rates be priced? Will I gain or lose on the rate change and can I negotiate which rate will apply?
- What about my accounting entries? Will my debt be deemed to have been modified under IFRS 9? What about my hedge accounting, will that be impacted by this change? What disclosures will I need to make?
In many cases, if the transition goes well and the market results in the rates being neutral, the accounting, tax and practical implications should not be significant. The right planning and paperwork will help you manage the risks. However, in certain businesses and industries, the risks and costs could be considerable if this isn’t done right.
Given the impact of the coronavirus, there is a chance that these changes could be delayed. However we suggest that you start engaging on this issue now, and consider where you are exposed to LIBOR.
We suggest starting with this simple three-step process:
- identify where the business uses LIBOR;
- perform a risk assessment with your advisers, to understand what the business needs to do to transition to SONIA (and/or other regimes according to currency and location) as well as the commercial and financial impact on the business; and
- design and implement a step plan to affect the transition.