According to Britain’s Financial Conduct Authority, the London Interbank Offered Rate, or LIBOR, will be phased out and abandoned by the end of 2021. This phase out will put lenders and borrowers in a tricky situation as LIBOR is the most commonly used interest rate index and is estimated to be tied to over $350 trillion of financial products globally, including commercial mortgages, corporate loans and swap transactions. LIBOR is calculated daily and aims to provide the average interest rate at which the 10 to 20 contributing banks may obtain loans from each other. Over the past ten years, LIBOR has been highly susceptible to rigging scandals and market manipulation since the calculation is often not underpinned by actual market transactions, leading to its eventual abandonment.
What should lenders and borrowers do to prepare for the end of LIBOR? Lenders and borrowers should monitor the development of alternative benchmark interest rates. Already, the Alternative Reference Rate Committee (a committee made up of private-market participants set up by the Federal Reserve) has “identified a broad Treasuries repo financing rate…as the rate that, in its consensus view, represents best practice for use in certain new U.S. dollar derivatives and other financial contracts.” Lenders and borrowers should also look to their financial contracts to see how the availability (or lack thereof) of LIBOR is addressed. Some agreements may point to a substitute benchmark rate – lenders should confirm that such substitute benchmark rate is clearly identified. Other agreements may state that another rate shall be chosen mutually or solely by the lender. The most problematic circumstance is if the agreement does not anticipate the absence of LIBOR at all. Lenders should address this uncertainty by ensuring that their current and future loan agreements contemplate a life without LIBOR.
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