Cash & Liquidity ManagementKeep your sights on the end of Libor

Keep your sights on the end of Libor

John Clarson of GTreasury discusses points to remember for the global transition to new reference rates from Libor (London Interbank Offered Rate)

By now, corporate treasury professionals should be well aware of the looming transition away from Libor (London Interbank Offered Rate). Libor has been used for decades as the interest rate benchmark for a wide variety of financial instruments. Its demise will require global adoption of new reference rates, and all financial instruments and contracts with maturity dates after 2021 must be revised if based on a Libor reference rate.

However, the global transition to new reference rates is a mind-boggling undertaking. In the US alone, it is estimated that nearly $200trn worth of financial contracts in mortgages, corporate debt, business and consumer loans, derivatives and other financial instruments reference Libor rates. Libor is also widely used as a benchmark to gauge investment costs and returns.

More than six months ago, the US Securities and Exchange Commission urged “market participants who have not already done so to begin the process of identifying existing contracts that extend past 2021 to determine their exposure to Libor.” It is likely that most contracts that reference Libor do not have fallback language in place that outlines viable provisions if publication of the Libor rate is discontinued. As a result, there may be significant disagreement among the contract parties or other unforeseen issues that arise when adjusting the contract to a new reference rate. Therefore, the Commission “encourages market participants to focus on [the issues] now to avoid business and market disruptions after 2021.”

Understand your exposure

Recognising that the end of Libor could cause market disruptions, your first priority should be to take stock of the extent of your organisation’s potential liability. If you haven’t already done so, start by identifying all the contracts that have terms extending past 2021. How many of them contain language referencing Libor rates? What effect will the permanent end of the Libor rate have on the execution of the contract? Does the existing contract fallback language provide an alternative if the Libor rate is not available?

Select an alternative reference rate

In the US, the Alternative Reference Rates Committee (ARRC), has selected the Secured Overnight Financing Rate (Sofr), as the preferred alternative to the US dollar Libor. However, it’s not an apples to apples transition. The Libor rates have traditionally been based on the rates banks reported they would charge other banks for short-term loans, in other words, a “best guess” rate. Sofr is based on historical transaction data. Libor also offers several maturity term rates while Sofr is just an overnight rate.

The differences in the way the reference rate is calculated could have significant impact on the execution of the contract. It’s important to understand the full extent of the ramifications before attempting to renegotiate terms.

Identify next steps

Some type of action will need to be initiated to resolve the uncertainty and risks associated with the contracts that do not have provisions to handle the permanent end of Libor and transition to an alternative reference rate. In November 2019, the ARRC published the Summary of ARRC’s Libor Fallback Language to help companies standardise provisions set out in any contracts referencing Libor. It contains guidelines for successor rates, spread adjustments and trigger events that you may be able to use to amend your contracts that reference Libor.

Nonetheless, you will most likely need to renegotiate the terms or otherwise determine how your contracts can be amended to the satisfaction of all parties. Take the time to analyse how the contract will be affected, then identify what terms your organisation needs to make the contract whole again. Set up negotiations sooner, rather than later, to ensure no disruption occurs should Libor end sooner than expected.

Prepare your systems for the transition

Work with your vendors to learn where your internal adjustments may need to be made for a seamless transition to a new reference rate or new contract terms. Will you need to allocate additional resources to manage updates? Will required resources come from your internal team, or will you have to set aside budget for external resources?

Time is of the essence

It’s widely acknowledged that after 2021, Libor will no longer be the ubiquitous reference rate it has been. The transition to a new reference rate is a foregone conclusion. What’s more, as the US SEC stated in the document referenced earlier, “the risks associated with this discontinuation and transition [of Libor] will be exacerbated if the work necessary to effect an orderly transition to an alternative reference rate is not completed in a timely manner.” In essence, the sooner you initiate and plan for the end of Libor, the better chance you have of minimal disruption to your operations.


John Clarson is the director of Quantitative Analysis at GTreasury. His expertise includes hedge accounting, financial risk, ALM, interest rate derivatives and risk management, and he has a demonstrated history of solving real world problems in the financial services industry.

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