Preparing for the LIBOR Transition: What Missouri Banks Need To Do Now

By Christopher Rockers, Nicholas Kenney and Ani Kaufmann Mamisashvili

Husch Blackwell
The use of LIBOR is drawing to an end. For decades, financial institutions have used LIBOR (the London Interbank Offered Rate) as the prevailing reference rate for determining interest rates in commercial and financial transactions. As a response to the manipulation of LIBOR almost a decade ago, the United Kingdom’s Financial Conduct Authority announced in 2017 it did not expect LIBOR to remain as an acceptable benchmark for floating interest rates beyond 2021.

Although the LIBOR transition is still in process, there are some settled ways to deal with the transition and trends in the replacement rate for LIBOR. Preparing now for this transition is important.

Current State of LIBOR

LIBOR is calculated from estimates submitted by a panel of leading London banks. Today, commercial contracts totaling nearly $200 trillion use LIBOR as a “benchmark.” 

On March 5, 2021, Intercontinental Exchange and the FCA confirmed that LIBOR will phase out by June 30, 2023, and one-week and two-month LIBOR will cease being published by Dec. 31, 2021. On March 9, 2021, the Alternative Reference Rate Committee confirmed that ICE’s announcement of a definitive cessation date for LIBOR tenors constituted a “Benchmark Transition Event,” which began the process of switching from LIBOR. However, this “Benchmark Transition Event” does not require an immediate transition.

How to Transition to a New Reference Rate

New contracts executed before Dec. 31, 2021, should use a non-LIBOR reference rate or have robust fallback language, including a clearly defined alternative reference rate to replace LIBOR. The ARRC, a group of private-market participants convened by the Federal Reserve, has proposed using the Secured Overnight Financing Rate to replace LIBOR.

SOFR is a risk-free, daily, overnight rate and based on actual interbank transactions with daily volumes approaching $1 trillion. SOFR is calculated daily and can be simple (Daily Simple SOFR) or compounded (Daily Compounded SOFR). Because LIBOR is a credit-sensitive rate and SOFR is a risk-free rate, there are established spread adjustments to cause SOFR based rates to align with LIBOR. SOFR also can be calculated for forward-looking tenors and published by an authorized benchmark administrator. Such forward-looking SOFR is referred to as Term SOFR.

Daily Simple SOFR and Daily Compounded SOFR are similar, so the ARRC recommends the use of Daily Simple SOFR to keep calculations simpler. We have seen at least one market participant in a new contract use Daily Simple SOFR as the reference rate, with fallback language to Term SOFR once it is established or a different rate that becomes more appropriate. Some lenders also have discussed using other reference rates, which may be credit-sensitive rates such as a rate called AMERIBOR. To date, comparable credit-sensitive rates do not appear to have much of a following, and we have seen only isolated instances where such reference rates have been used.

How Can Lenders Protect Themselves?

It is imperative that lenders address the legal and operational risk they might have with LIBOR transition. Banks should examine their existing loan documents to quantify their LIBOR exposure and to understand how fallback reference rates will be determined. If no methodology is included, one will need to be added in the loan documents. Fallback language that only addresses LIBOR’s temporary unavailability may not suffice because LIBOR will be permanently discontinued. Moreover, if existing loan documents fallback to the “prime rate,” it still might not be an ideal long-term reference rate or an acceptable replacement for borrowers.

Lastly, for loan documents that use LIBOR, lenders should consider approaching borrowers to propose amendments that provide clear language that addresses LIBOR transition. If you use third-party vendors to produce loan documents or maintain any of your operations systems, you should contact them regarding steps they are taking to transition away from LIBOR and system updates.

It is important that lenders properly prepare for the LIBOR transition. There is still a lot of uncertainty on what the LIBOR transition will bring. Although this transition may be disruptive in the short term, moving to SOFR or another similar reference rate should bring further stability to the financial markets over the long-term.

This article, published in the July/August 2021 issue of The Missouri Banker, was submitted by MBA associate member Husch Blackwell LLP. Christopher Rockers is a Kansas City-based partner with the law firm Husch Blackwell LLP and co-leads the firm’s LIBOR team. Nicholas Kenney and Ani Kaufmann Mamisashvili are attorneys in Husch Blakckwell LLP’s Kansas City office and are members of the firm’s banking and finance team. Visit huschblackwell.com to learn more.
 

MBA Podcast Episode with Husch Blackwell

Chris Rockers, a partner at Husch Blackwell, discusses the upcoming LIBOR transition on Our Two Cents with MBA. New business will have to be written using an alternative reference rate after December 31, with the leading candidate being SOFR. This issue has remained somewhat under the radar because of COVID and economic recovery efforts, but it represents a major shift for our financial system. Regardless of the size or geographic region of your bank, you must ensure that you are aware of where you have LIBOR exposure and have a plan in place to address it.

Our Two Cents with MBA podcast is available on iTunesApple PodcastsGoogle Podcasts and Spotify