Life After Libor
The Financial Conduct Authority (FCA) has heralded the end of Libor (London interbank offered rate) and called for more reliable alternative benchmarks to be introduced by 2021.
Libor is the benchmark rate at which London banks lend funds to each other. Simplistically put, a panel of City lenders are asked at what rate they could borrow ‘X’ currency that day from another lender. Their responses are then averaged and the resultant figure is published daily.
The practice of lending between banks has tailed off substantially since the 2008 financial crisis and as such the FCA believe that Libor is no longer a sufficiently reliable indicator and therefore not fit for purpose.
The FCA advise that work has already begun on the process of transitioning to alternative benchmark rates that are based more firmly on real world transactions. It’s expected that this transition will take up to five years and it’s not yet clear what the industry standard will be going forward.
Application to legal documentation
Libor is frequently used as a reference rate in variable rate commercial loan facilities. It’s likely that many such loans will of course expire during the five year phase-out period and therefore not be exposed to the post-Libor era. However, given the uncertainty over its future, borrowers should take heed of the warning that a period of Libor volatility may well be on the horizon.
At any rate, many such commercial facility agreements provide for a substitute benchmark rate in the event Libor is either no longer available or no longer accurately reflects to cost to the lender of granting the loan. There‘s no real market standard substitute benchmark rate however. Fallback provisions on substitute rates can vary between lenders and may even vary between loans provided by the same lender. It should of course be borne in mind that the substitute may consistently produce rates that are typically higher than Libor which could result in a significant cost increase to the borrower. This is of course to be expected as an alternative benchmark rate will of course ultimately be arrived at by polling a different panel of lenders’ responses to a different question.
We think our current facilities may leave us exposed once Libor is scrapped. What can we do about it?
It’s worth reviewing your current borrowing arrangements to determine exposure to Libor based transactions and what, if anything, these provide for in the way of substitute benchmark rates. If a substitute rate is provided then it’s advisable to work through how the new variable rate will be calculated and model this against the current Libor arrangement. If this is likely to result in substantially increased costs under the new benchmark then it might be advisable for borrowers to seek to vary their existing agreements now while the loan is in good standing rather than down the line.
Naturally you may also wish to ensure that the issue of an appropriate substitute benchmark rate is addressed in any relevant transactions you are contemplating in the near future.
As stated above, at present it’s far from clear what the industry standard in this area will be once Libor is scrapped. Keeping aware of developments and reviewing current Libor based facilities will likely assist borrowers seeking to avoid paying over the odds to service their current liabilities.Back to news list