The LIBOR transition

The LIBOR transition

August 08, 2019 | By Keith Martin in Washington, DC

The LIBOR transition is getting high-level attention in Washington.

The US Securities and Exchange Commission urged companies in a “staff statement” in July to identify existing contracts that rely on LIBOR and begin negotiations now if a contract is unclear about what happens once LIBOR is discontinued. It also recommends using an alternative benchmark rate called SOFR for future transactions that use US dollars.

The interest rates on most floating-rate loans are tied to LIBOR, as are swaps and other contracts where the parties have payment obligations to each other that accrue interest when payments are delayed.

Banks that currently report information that is used to set LIBOR are expected to stop doing so after 2021. Thus, loans, swaps and other contracts that run past 2021 are potentially affected.  

Working groups have been formed in each of the United States, United Kingdom, European Union, Japan and Switzerland to recommend alternatives to LIBOR for transactions in the different currencies. An alternative reference rates committee — ARRC — in the US, led by the US central bank, identified the “secured overnight financing rate” or SOFR as its preferred alternative.

SOFR is a measure of the cost of borrowing overnight cash using Treasury securities as collateral. The overnight lending market has $800 billion in daily volume.

The SEC paper, called “Staff Statement on LIBOR Transition,” recommends that companies first identify existing contracts that run past 2021 for potential exposure to LIBOR and make sure the parties agree on what happens once LIBOR is discontinued.

The alternative reference rates committee has published separate fallback provisions for use in new floating rate loans, syndicated loans, bilateral loans and securitizations. The International Swaps and Derivatives Association (ISDA) is still working on fallback language to use in swaps.

The disappearance of LIBOR could also affect base case models and tracking models in tax equity deals. The SEC staff recommended that companies focus on the potential effects on “strategy, products, processes and information systems.”