LIBOR REPLACEMENT DURING 2021
The London Interbank Offered Rate (“LIBOR”) backs trillions of U.S. dollars of financial products across currencies, jurisdictions, and asset classes. It is widely spread and once has been called the “world’s most important rate.” 2020 changes have also target LIBOR in the sense that Global regulators have signaled the termination of LIBOR by the end of 2021.
The leading question is if you are prepared for the “transition” — from LIBOR to, i.e., the U.S. dollar-denominated loans and securities/secured overnight financing rate (SOFR), a benchmark interest rate for dollar-denominated derivatives and loans, that is expected to replace LIBOR? The ancient continent also informed that the European Central Bank would create an alternative index too.
SOFR is based on transactions in the U.S. Treasury repurchase, or repo market, in which banks and investors borrow or lend Treasuries (Treasurys) overnight. The main difference between the LIBOR and the SOFR is that this last one is calculated based on actual basket of transactions and not an estimate, and has been modeled after 4 (four) years of studies and analyses led by the Alternative Reference Rate Committee – ARRC (Federal Reserve).
Is it my problem or only for Banks / Financial Institutions / Debtors?
If you are a LIBOR user, I would surely and affirmatively say “Yes” because the ceasing of its use would directly affect the transactions by it backed, in case there is no supplemental or alternative rate provided for.
Additionally, corporates rely on LIBOR in critical internal systems and risk models, as well as in various types of regular commercial contracts, as such purchase agreements and vendor agreements.
Through a quick check we have not noticed any Brazilian regulation on this matter already, but we will revert to you shortly as soon as it is released.
5-step smooth transition
In this sense, we would like to highlight five (5) steps we consider highly regarded for a smooth LIBOR-to-SOFR(?) transition:
(a) identify all LIBOR-based contracts as issuers and buyers, define all triggering events, identify all replacement rates following a triggering event, calculate the adjustment referring to the change (whether positive, negative or zero) and specify how the contract can be changed (waivers needed, prior or not consent of all parties…) to determine which contracts should be remediated;
(b) verify and minimize any mismatches between obligations and derivatives – history has shown us that this is a valuable proactive/preventive action and can save your business;
(c) analyze all material and actual risks involved (economic, legal, including but not limited litigation, tax, regulatory, operating and accounting), identify and implement risk mitigants;
(d) prepare and implement communications and regulatory engagement by communicating and engaging corporate governance boards and senior management, stakeholders, counterparties, and regulators. Consider appointing a PMO; and
(e) timely and successfully (i) convert existing systems and (ii) amend/remediate (1) existing contracts (engaged with financial, risk, treasury, operating and legal staff, update key internal (commercial/vendor/financial/treasury), (2) existing systems and (3) paper transition/implementing, including but not limited with regulators.
This is Taylor-made process and shall require some quality time to path the 5-step out with consciousness and success.