LIBOR, which stands for London Interbank Offered Rate, has been used as a reference rate across the world, but the standard is officially retiring at the end of this year. Learn the steps your company needs to take to prepare for the post-LIBOR financial landscape.
What Does the LIBOR Transition Mean?
A significant challenge of the LIBOR retirement is the amending of financial contracts and documents already in place. Payments that were tied to one standard are now tied to a different standard, potentially changing expectations of one or more parties to a contract or agreement.
While a short-term unavailability of LIBOR was a minor blip, over the lifetime of a contract, the financial implications could be major. Thus, it’s critical that the transition goes smoothly. Professional organizations, national banks and other parties have already invested significant time and resources into ensuring a smooth transition. The work left to do is largely administrative: updating documents and preparing for forthcoming transactions that will not reference LIBOR, but a new standard rate.
With the clock ticking, use this checklist to prepare for the transition away from LIBOR.
LIBOR Transition Checklist
Make a transition plan
Coming up with a plan to alter contracts that rely on LIBOR is the first step to this shift. Artificial intelligence can scan contracts for references to LIBOR and for any fallback language dictating what would happen if LIBOR standards weren’t available. Such fallback language was developed as a failsafe for any “what ifs,” but when LIBOR is officially retired, it will dictate the terms of the agreement. Originally put in as a contingency, the fallback language may not be rigorous enough to prevent disruption if, for instance, the markets react to LIBOR’s retirement.
Once you know how many documents need remediation, you can formulate a plan to amend contracts. Changing contracts will look different for different firms, as so much depends on the the details. Some contracts may need to be closed while others can be changed. By getting a big-picture overview of how much work needs to be done, companies can plan, budget and allocate staff time to get the work done. Time is of the essence, so companies must get started if they haven’t yet.
Get to know the replacement rates and ISDA protocol
ISDA, which stands for the International Swaps and Derivatives Association, formalized a protocol to guide companies through the LIBOR transition. The protocol defines key terms and best practices, essentially giving companies a guide toward the steps needed to amend contracts.
LIBOR is widely used in five currencies: USD, GBP, EUR, JPY and CHF. Each national bank from those nations is able to select its own alternative rate, simplifying work for financial institutions. Still, it is important to understand how these replacement rates will work and determining whether to base forthcoming transactions on forward-looking or backward-looking rates.
Covid-19 has affected some time frames for this transition, but analysts do not expect the end-of-year deadline to change. While companies should stick to the agreed-upon schedule, it’s important to monitor for any regulatory changes that could affect the work.
While there is a lot of work to be done to move past LIBOR, companies don’t need to do it alone. Artificial intelligence can take care of much of the data management and review. Law firms and technology service providers can also assist with the transition. Once companies understand the scope of work, they can seek assistance to ensure they finish before the deadline.
Adam Nguyen is Senior Vice President for Donnelley Financial Solutions™, a global trade finance solutions company. He has many years of experience in the industry and focuses on the company’s financing activities and daily operations.