The cessation of libor by the end of 2021
??As announced by the UK Financial Conduct Authority (“FCA”), the London Interbank Offered Rate (“LIBOR”) shall discontinue to exist, with certain panel banks withdrawing from the benchmark. This announcement marks a significant milestone after its role as the most prominent and commonly used interest rate benchmark for decades. All LIBOR-based agreements that mature beyond 2021 will likely require amendment to alternative rates.
Background
LIBOR was first calculated by banks as a benchmark interest rate to reflect the expected interest rate at which banks could borrow unsecured funds in the interbank market. Historically, LIBOR was a key benchmark interest rate used globally across a wide range of financial instruments.
Following the 2008 financial crisis, significant weaknesses were identified in the LIBOR benchmark, particularly regarding the lack of transparency and reliance on expert judgment rather than actual transactions. These concerns resulted in regulatory scrutiny and reform initiatives.
The FCA announced in 2017 that it would no longer compel banks to submit to LIBOR after the end of 2021, leading to the planned cessation of LIBOR and the transition to alternative reference rates.
Potential Alternatives to LIBOR
In July 2017, the FCA confirmed that it would no longer require panel banks to submit to LIBOR beyond the end of 2021. Since then, global regulators and industry bodies have worked on identifying alternative benchmark rates.
In the United States, the Alternative Reference Rates Committee (“ARRC”) selected the Secured Overnight Financing Rate (“SOFR”) as its preferred alternative to USD LIBOR. SOFR is based on transactions in the U.S. Treasury repurchase market and is considered more robust due to its reliance on observable market data.
In the United Kingdom, the Sterling Overnight Index Average (“SONIA”) has been identified as the alternative risk-free rate to GBP LIBOR.
Other jurisdictions have similarly adopted overnight risk-free rates as replacements for LIBOR, including the Euro Short-Term Rate (€STR) in the Eurozone and the Swiss Average Rate Overnight (SARON) in Switzerland.
Transitioning to Alternative Rates
Transitioning to alternative rates presents challenges, particularly because LIBOR incorporates a forward-looking term structure and credit risk premium, whereas most alternative rates are backward-looking and nearly risk-free.
Market participants must review existing contracts to identify LIBOR exposure and assess fallback provisions. Where fallback language is insufficient or absent, contractual amendments may be required.
Regulators and industry groups have issued guidance to facilitate the transition process and mitigate risks associated with the cessation of LIBOR.
Further Actions to be Taken
Many regulators and financial institutions are in the process of establishing a strategy to implement the anticipated transition. They have been engaging with clients to prepare for the LIBOR discontinuation and ensure appropriate steps are taken to address and mitigate the impact of the transition.
It is advisable that market participants consider the cessation of LIBOR and its implications for their financing arrangements. They should review existing contracts and agreements to determine whether amendments are necessary and assess the impact on pricing, hedging, and risk management strategies.
Conclusion
With the cessation of LIBOR fast approaching, market participants need to proactively assess and address their exposure to LIBOR-based instruments. Early preparation and engagement with counterparties will be key to ensuring a smooth transition to alternative reference rates.
Authors
May El Ghazary
Counsel
[email protected]
Patricia Fernandes
Associate
[email protected]
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