The End of LIBOR – What to expect?
The globally recognised and crucial London Interbank Offered Rate (LIBOR) is understood to be the benchmark interest rate for a reported US $300 trillion worth of financial contracts worldwide, including around $30 trillion worth of financial contracts in GBP. However, the Financial Conduct Authority (‘FCA’) has recently once again stressed that banks should not assume that LIBOR would remain as a viable benchmark beyond 2021.
LIBOR is the average rate at which leading banks are willing and able to obtain unsecured funding in the London interbank market. The use of LIBOR was previously seen as a benefit to corporate borrowers in that they would not be exposed to a particular lender’s financial stability which would result in a higher lending cost than other leading lenders in that market. The FCA’s attitude towards LIBOR has arisen in response to the infamous rate-rigging scandals which first came to light in 2008, in which bankers at various financial institutions manipulated LIBOR for profit.
LIBOR is primarily used within finance documents as the rate of interest which is applicable in an event of late payment. It is also used in a wider range of agreements – for example within construction contracts and operation and maintenance contracts. As a result, a number of longer-term projects with terms extending beyond the FCA deadline in 2021 will need to consider the impact of the potential cessation of LIBOR on their contractual arrangements. Industry bodies are therefore strongly encouraging lenders and borrowers to prepare for the transition as soon as possible.
The cessation of LIBOR beyond 2021 will therefore impact on both new and existing contractual arrangements:
A number of new benchmarks have been proposed as alternatives to interbank offered rates, known as risk-free reference rates. One example of an alternative to LIBOR is the Sterling Overnight Index Average (‘SONIA’). SONIA reflects the average interest rate which banks will pay to borrow sterling overnight from other banks. This rate has already been rolled out to an extent in the UK, with Natwest announcing in June 2019 that they were the first UK bank to trial a SONIA-based loan product.
However, SONIA is yet to gain full momentum in new financing arrangements and, as a result, banks are continuing to use LIBOR as the default rate within such financing contracts. However, given the inherent uncertainty with the timing of the cessation of LIBOR and additionally the preferred replacement rate for LIBOR, lenders are relying in ‘fallback’ provisions within facility arrangements to cater for amendments when LIBOR is no longer in use.
However where agreement cannot be reached on lenders unilaterally nominating a replacement rate of interest, parties are increasingly using a procedural mechanism within the agreement to decide on a replacement rate for LIBOR. This includes mutual agreement, a formally designated replacement rate for LIBOR or where neither is applicable, an independent decision by a body such as the government.
A number of existing longer-term contracts, in place prior to the FCA decision in 2017, may not contemplate the cessation of LIBOR, and we would recommend a review is carried out of these arrangements to determine what rate is applicable post-LIBOR. Parties may wish to adopt a ‘wait and see’ approach, to find out which rate is to be formally designated as the replacement for LIBOR. Alternatively, parties may wish to address their existing arrangements to come to a mutual agreement with the counterparty on the replacement rate for LIBOR.
How can we help?
We advise both lenders and borrowers in the banking sector on their financing arrangements. For strategic advice on the phase-out of LIBOR and what action should be taken now in anticipation of the phase-out, contact our expert banking lawyers as soon as possible.
This reflects the law and market position at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought in relation to a specific matter.
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