The United Kingdom Financial Conduct Authority announced their plan to phase out the London Interbank Offered Rate (LIBOR) by 2021 last July. This transition marks the “end of an era” as the key interest-rate indicator that has supported trillions of dollars in financial instruments over the last fifty years is phased out. Critics of LIBOR have long expressed discontent with the fact that the index relies upon financial industry experts’ best guesses or theories, rather than actual transactional evidence.
The time is now to fully prepare for this eventuality and consider putting into place protections for the uncertainty ahead. The transition will be less risky and less expensive if it is planned methodically. As you prepare to transition away from LIBOR, existing loans tied to the benchmark should be reviewed.
Here are some helpful guidelines for lenders with portfolios based on LIBOR:
- Determine if amendments are permitted and needed to account for the end of LIBOR and entry of a new rate.
- Determine if your loan documents include sufficient language to choose a replacement rate in the event that LIBOR ceases to be published.
- New loan documents should be written to include Fallback Provisions.
- Fallback Provisions should provide a clear alternative for choosing a rate if LIBOR is discontinued altogether.
- Fallback Provisions should include language that protects the lender if LIBOR continues to be published with less regulation and becomes an unreliable rate. (In this case, lenders would want the option to change the interest rate calculation)
- Ensure that Fallback Provisions are broad enough to cover all of the possibilities of LIBOR’s future.
LIBOR is a cornerstone of today’s global financial industry, and the significance of its replacement should not be underestimated. The shift away from the infamous benchmark will present yet another challenge for firms in the face of an ever-evolving regulatory landscape. The risk is real, and if plans to mitigate the impact of such a significant change are not put in place then firms will put themselves at further risk in an already turbulent post-crisis regulatory environment.