The End of LIBOR – a brave new world!

LIBOR has been a part of the commercial landscape for well over 30 years now. It has been integrated deeply into business practices - not only debt and hedging transactions, but also for many other commercial contracts that need to invoke a benchmark reflecting a commercial rate of return on credit risk.

However, LIBOR was not without its well-publicised issues and now, LIBOR is widely anticipated to be discontinued by the end of 2021. This is going to create a far-reaching and fundamental shift in how benchmark rates are calculated. The practical outcome means that, if not managed correctly, there is the potential for serious and adverse consequences for corporate borrowers.

Participants in the financial markets are now moving away from using unrepresentative interbank offered rates (or IBORs) to alternative reference rates in readiness for the exodus from LIBOR before the end of 2021.

It’s fair to say that the LIBOR transition has become a “hot button” issue for Australian corporate borrowers that access debt and hedging (swap and FX for example) in loan markets. This is because, if the transition is not managed correctly, potential adverse effects can arise. These may include:

• interest costs increasing (as lenders may pass on the cost of funds to borrowers as an alternative to a replacement rate);
• hedging agreements ceasing to reflect the original commercial purpose; and
• floating rate interest fixing to the last available published floating rate (which may not be an appropriate forward based mechanic).

Two risk free reference rates (SOFR (for U.S. dollars) and SONIA (for sterling)) can now be considered as part of the wider solution to replace LIBOR. More detail on these rates and the LIBOR transition can be accessed in an earlier article we have published. Those benchmarks should be examined to understand how they may be implemented (and differ) from LIBOR and how their adoption may affect your business.

The transition away from LIBOR needs to be handled with care. We are currently recommending to our clients that they take the time now to consider the various ways that the end of LIBOR should be addressed by the business. This should involve establishing a working relationship between key internal decision makers and trusted external advisors with expertise in advising on debt and hedging arrangements.

We also view the next six months as critical in managing the transition process, with a deep dive into existing finance documents as an important early step.

The team at Wright Legal are very experienced in debt and hedging arrangements (it’s what we do) and we welcome the opportunity to discuss your LIBOR transition plan with you.