The clock is ticking on LIBOR.
LIBOR, the London Inter-Bank Offering Rate, underpins the benchmarking of interest rates used across global financial markets. LIBOR is used in the rate setting for transactions in derivatives, bonds, loans and other financial contracts and drives trillions of pounds worth of business every year.
However, LIBOR was heavily discredited when it was manipulated in the rate-fixing scandal unearthed in 2012—multiple high profile banks were prosecuted by industry regulators in subsequent years, all of which suffered reputational damage as well as hundreds of millions of dollars in penalties.
Largely as a result of this scandal, combined with the outdated process by which it is set, regulators are calling time on LIBOR, replacing it with multiple alternative benchmarks called overnight risk-free rates (RFRs). These alternative rates are aligned with global financial centers: the Sterling Overnight Index Average (SONIA, the direct replacement for LIBOR) in the UK, the Euro Short-Term Rate (ESTR) from the European Central Bank in Germany, the Swiss Average Rate Overnight (SARON), Japan’s Tokyo Overnight Average Rate (TONAR) and the Secured Overnight Financing Rate (SOFR) in the US—which takes away the liability from just one rate.
The deadline for transitioning away from LIBOR is officially the end of 2021 but, in reality, the issue is much more pressing. New contracts are still being created that reference LIBOR beyond the planned deadline for it being discontinued. Worse still, the word from regulators like the Financial Stability Board (FSB) and Financial Conduct Authority (FCA) is that the virus crisis will not be allowed to derail plans for moving away from LIBOR; despite some regulatory deadlines being reprioritized, the LIBOR transition will continue along the existing timeline.
So central banks and regulators around the world are now combining forces to increase the pressure on firms using LIBOR to encourage a more rapid transition; specifically, they are highlighting the risk of legal uncertainty on contracts that reference LIBOR as well as ensuring that new business is shifted from LIBOR to the newer alternative rates. In short, each firm needs to formulate a transition plan away from LIBOR and execute all new contracts against RFRs.
One of the major issues related to this transition is the sheer amount of content relating to this critical financial mechanism. LIBOR has been the standard for benchmarking interest rates since the mid-1980s, so it is firmly established in the working practises of financial institutions. This means that both financial firms and their customers will need to update or rewrite existing documentation, as well as creating new documentation for adopting a process for working with one or more of the RFRs.
These materials will fall into a number of critical categories:
- Contracts: Complex cross-border contracts exist for the high value, high volume transactions that take place between financial institutions as well as between those firms and their customers. The challenge is not just in identifying and remediating those contracts, but also in accurately translating them for global stakeholders in the critical relationships impacted by the transition. We’re not the only ones raising this as an issue, and encouraging companies to expedite their transition process. Deloitte is offering practical considerations for repapering of contracts in their LIBOR Reform Perspective, while SDL offers expert legal translation services that support this multi-faceted exercise.
- Policies and procedures: The complicated transactions driven by LIBOR and other interest rate benchmarks require aligned processes between departments within an organization and in a firm’s dealings with its partners and customers. Having clear processes also helps to ensure transparency in transactions, an area of particular importance given the manipulation of LIBOR in the years prior to 2012. Global organizations require that policies and procedures reside within a structured framework that delivers a single version of the truth to users wherever they operate; likewise, these materials also need to be localized into multiple languages to ensure complete clarity and consistency in their execution.
- Training materials: Subsequent to the updating of processes, HR and training departments also need to ensure that the necessary educational programs are implemented to enable rapid and uniform transfer of new knowledge to all relevant employees. This will frequently involve translation into multiple languages to account for global teams, as well as numerous formats to cater for in-person and eLearning training methods.
- Customer communications: Finally, but no less important than the other content areas, firms will need to embark on extensive communications programs to stakeholder audiences, especially customers and partners. This will likely involve prolonged interactions across a variety of channels, both as the transition to RFRs takes place and as the deadline for discontinuing LIBOR draws nearer.
Published on April 6, 2020 in Financial Services