Our experience shows that companies are commonly exposed to a variety of risks resulting from the discontinuation of LIBOR, including unfavourable contract conditions, operational risks, higher P&L volatility, and tax risks. CFOs and Corporate Treasurers are now encouraged to begin transition planning.
On 14 November 2018, the Financial Stability Board published a progress report stating that ‘transition is necessary’ for LIBOR-linked contracts prior to the rates’ discontinuation after 2021. This affects contracts with hundreds of trillions of dollars in notional volume which are LIBOR-linked and with maturities running beyond 2021. The transition to alternative benchmarks means that market participants need to begin remediation efforts now.
If you are the CFO or treasurer of your organisation, consider the following: Have you assigned responsibility to a project manager to identify your group’s exposures to LIBOR-linked contracts? Are you aware of the current fall-back provisions that will be triggered should your group fail to adjust all contracts in time? Is your group continuing to enter into new LIBOR-linked contracts, despite being aware that such reference rates will be discontinued after 2021? Do you know the average basis spread between SARON and CHF-LIBOR, or between SOFR and USD-LIBOR? Do you have sufficient data to coherently renegotiate contracts at advantageous terms?
The transition away from LIBOR can be traced back to July 2014, when the Financial Stability Board (FSB) published a report calling for reform. The report shone a spotlight on the vulnerability of LIBOR to manipulation, given that such rates are based on submissions by a very limited number of contributing panel banks. In addition to that, LIBOR is meant to represent interbank lending rates on an unsecured basis. As the overwhelming majority of interbank lending is conducted on a secured basis, LIBOR has increasingly come to represent the panel banks’ best estimate of interest rates which are seldom used in practice.
In response, national working groups were established to provide recommendations to strengthen the existing benchmark interest rates around the world, and to replace LIBOR with alternative reference rates (so called ‘nearly risk-free rates’ or RFRs) which are based on observable market transactions. The aim was to create benchmark rates that are more robust and resilient to abuse.
Panel banks will no longer be compelled by regulators to submit LIBOR estimates beyond 2021. Consequently, LIBOR rates are not expected to be published beyond this date. As of year-end 2018, alternative overnight reference rates have been freely available in USD, CHF, GBP, and JPY. The EUR RFR remains under development, with the European Central Bank expected to start publishing the Euro short-term rate (ESTER) by October 2019 at the latest.
OTC derivative markets using the new benchmark rates (except for EUR) are already building in depth and liquidity. As a safeguard, the International Swaps and Derivatives Association (ISDA) is developing language for standard contractual fall-back provisions that may be used when companies fail to update contracts in time. Furthermore, the International Accounting Standards Board (IASB) is in consultation with market participants to define how international accounting rules (IFRS) are likely to be impacted by the transition away from LIBOR, notably in the context of the rules on hedge accounting.
LIBOR replacement rates
|Existing LIBOR rate||Proposed alternative benchmark||Borrowing type||Regulatory working groups|
|EUR LIBOR||Euro short-term rate (ESTER)||Unsecured||European Working Group|
|USD LIBOR||Secured overnight financing rate (SOFR)||Secured||Alternative Reference Rates Committee (ARRC)|
|GBP LIBOR||Reformed Sterling overnight index average (SONIA)||Unsecured||Bank of England's Working Group on Sterling Risk Free Reference Rates|
|CHF LIBOR||Swiss average rate overnight (SARON)||Secured||National Working Group on Swiss Franc Reference Rates|
|JPY LIBOR||Tokyo overnight average rate (TONAR)||Unsecured||Japanese Study Group on Risk Free Reference Rates|
Corporate treasurers have been aware for quite some time that the discontinuation of LIBOR would have a considerable impact, with hundreds of trillions of dollars in contracts (notional volumes) requiring adjustments by the end of 2021. Not all CFOs and treasurers, however, have grasped the risks posed by an unprepared transition. Our experience shows that companies are commonly exposed to a variety of risks resulting from the discontinuation of LIBOR, including:
|Unfavourable contract conditions||
|Higher P&L volatility||
The discontinuation of LIBOR has manifold consequences:
- Traditional LIBOR rates are expected to be discontinued after 2021.
- The replacement benchmark rates are more robust and less exposed to abuse.
- The pervasiveness of LIBOR’s use in corporate treasuries, and in financial contracts more broadly, leads to far-reaching adjustments being necessary.
- Reluctance to mitigate exposures to LIBOR will put your company at risk, at potentially significant cost.
Treasurers and CFOs now need to develop a roadmap towards the post-LIBOR world. If your organisation has not yet completed its transition roadmap, our PwC experts are available to assist you.