The discontinuation of LIBOR represents one of the most fundamental changes in the banking and finance industry in the last decade and it will directly affect a broad range of organisations across all sectors.
Whilst those of you who work in-house at our banking and financial service clients will most likely have spent much of the past year (or longer!) agonising over the best approach to deal with the discontinuation of LIBOR, for others this might have been less of a focus. However, the discontinuation of LIBOR will impact many existing and future financing arrangements you have in place. We hope this article will provide useful background on the impending changes and flag the issues you should be thinking about at this stage.
What is LIBOR and who uses it?
LIBOR is one of the main interest rate benchmarks (along with base rate and fixed rate). It reflects the rate at which large banks lend unsecured funds to each other in multiple currencies and for various maturities. Panel banks submit the rate they pay, or would expect to pay, for borrowing from other banks and an average of those submissions is compiled and published daily. In line with market practice, a significant proportion of lenders lend on the basis of LIBOR and many other entities (including businesses, property businesses, family office, charities and private individuals) have LIBOR linked loans or similar products outstanding.
LIBOR is not only used by banks. Other entities often use LIBOR as a reference rate for intragroup lending, in commercial contracts or derivative products, such as interest rate hedging/swaps.
What is happening?
Due to well publicised scandals regarding the manipulation of LIBOR, the FCA has made the decision to phase out the use of LIBOR across the banking and financial sector by the end of 2021. Most banks are well advanced in their preparations for this and may have already been in touch with their borrower clients about what they are doing.
The leading alternative to Sterling LIBOR is SONIA, an overnight sterling rate administered by the Bank of England and calculated using real data rather than subjective views. Banks should already (as of the end of September 2020) be including contractual provisions in all new and re-financed LIBOR-referencing products with a maturity date after the end of 2021, to enable conversion from LIBOR to SONIA or some other rate, such as base rate, and the industry anticipates that new LIBOR products and contracts will be actively phased out by the end of Q1 2021.
What should you expect and what should you do?
LIBOR is a unique type of interest rate benchmark and the alternatives, including SONIA and base rate, are very different and may produce a very different economic effect, depending on how a switch to an alternative rate takes place, when it happens and which alternative rate is chosen. Tiny differences in this can have a huge impact when dealing with very large financial products.
For those of you who are seeking out new financing or refinancing any existing borrowing, you should expect to see new provisions referencing the alternative rate rather than the more familiar LIBOR. These provisions can be lengthy and complex and you may wish to analyse the commercial (and legal) impact.
For those of you with existing LIBOR linked loans, you will be contacted during the course of the next 12 months by your lender who will need to move you to a different rate - possibly by amending the existing documents. You may be asked to consent to or enter into negotiations to amend the terms of the loan and you should review any such request carefully.
How can we help?
The Banking and Financial Services team at Farrer & Co have been advising lender and borrower clients on the impact of LIBOR discontinuation and the introduction of SONIA and other alternative rates.
If you have any questions regarding LIBOR, what you might expect to hear from their lenders in the coming months, or the pros and cons of SONIA and other alternative reference rates, we are well versed in these matters and can offer practical and commercial advice.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, November 2020