Reed Smith Client Alerts

LIBOR is on course to be replaced with risk free rates (RFRs) after 2021. This memo focuses on U.S. dollars and discusses, from a borrower’s perspective, the status of the transition of USD LIBOR to SOFR, the legal documentation and provisions that are currently available to aide the transition, as well as the issues that borrowers should consider in preparation for the transition.

1. What is LIBOR, and what went wrong with it?

For decades, interbank offered rates (IBORs) have served as the reference rate at which banks borrow funds from other banks. The London Interbank Offered Rate (LIBOR), which measures the cost of unsecured borrowing between banks across five currencies (USD, EUR, GBP, CHF and JPY) and seven tenors (Overnight, 1W, 1M, 2M, 3M, 6M and 12M), is a barometer for the global economy and is widely used by financial institutions and investors who operate internationally. It is an interest-rate average calculated from submissions made by a panel of contributor banks in London. With LIBOR being the benchmark interest rate that underpins more than US$300 trillion worth of financial contracts worldwide, the importance of LIBOR as a global index in financial markets across the world has never been questioned.

However, since the global financial crisis in 2008, it has been discovered that certain contributor banks had manipulated their LIBOR submissions, which ultimately led to the LIBOR scandal and triggered concerns about the reliability and sustainability of certain IBORs in the unsecured interbank funding market.

2. When will LIBOR be discontinued, and which transactions will be affected?

The Financial Stability Board (the FSB) was established in April 2009 in the immediate aftermath of the LIBOR scandal, and was tasked with reviewing major interest rate benchmarks and coming up with suitable alternatives to the existing reference rates. In July 2014, the FSB set out its recommendations to reform major interest rate benchmarks, including key major IBORs, and opined that risk-free reference rates could be used as alternative reference rates.

Then in July 2017, the UK Financial Conduct Authority (the FCA) announced that they would no longer compel contributor banks to make LIBOR submissions after 2021, further accelerating the need for financial institutions and other market participants to move away from LIBOR.

The impending discontinuance of LIBOR will affect both new and existing loan facilities and other financial products referencing LIBOR which mature after the end of 2021.

3. Has COVID-19 postponed the deadline?

So far, no. On 25 March 2020, the FCA, the Bank of England and the Working Group on Sterling Risk-Free Reference Rates published a joint statement in which they confirmed that, despite the impact of COVID-19, the general timeline for LIBOR discontinuance by the end of 2021 had not changed, although they would continue to monitor and assess the impact on transition timelines.

On 29 April 2020, the FCA reaffirmed that there was no change to the 2021 date, but recognized the challenges posed by COVID-19 and pushed back certain milestone dates for the discontinuance of sterling LIBOR.