How The End of LIBOR Could Impact You
LIBOR is widely used in the U.S. to as a basis for variable-rate debt and interest rate swaps. However, because of recent LIBOR manipulation scandals and other factors, Andrew Bailey, Chief Executive for the Financial Conduct Authority of the United Kingdom has “made clear the need to transition away from LIBOR before end-2021.” He also says that, “Firms should treat it is as something that will happen and which they must be prepared for.”
In July, Bailey also noted that, “The base case assumption should be that there will be no LIBOR publication after end-2021.” Despite this, many financial institutions and their clients continue to use LIBOR as a basis to price their loans and swaps for agreements that extend beyond 2021.
Agreements that use LIBOR as its primary basis will typically have a “fallback provision” for a different reference rate in the event LIBOR rates are not readily available – either the prime rate or a rate which is typically close to the prime rate and set at the effective fed funds rate or they involve obtaining quotes from reference banks. In some cases, the difference between LIBOR and fallback rates could be significant.
The impact of the likely-end to LIBOR should be considered as you forecast upcoming periods and negotiate lending contracts/renewals; failure to be aware of this could result in significant unplanned financing costs, lender disputes and, as it relates to certain interest rate swap derivatives, unfavorable accounting adjustments.
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