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The globally recognised and crucial London Interbank Offered
Rate (LIBOR) is understood to be the benchmark
interest rate for a reported US $300 trillion worth of financial
contracts worldwide, including around $30 trillion worth of
financial contracts in GBP. However, the Financial Conduct
Authority ('FCA') has recently once again
stressed that banks should not assume that LIBOR would remain as a
viable benchmark beyond 2021.
LIBOR is the average rate at which leading
banks are willing and able to obtain
unsecured funding in the London interbank market.
The use of LIBOR was previously seen as a benefit to corporate
borrowers in that they would not be exposed to a particular
lender's financial stability which would result in a higher
lending cost than other leading lenders in that market. The
FCA's attitude towards LIBOR has arisen in response to the
infamous rate-rigging scandals which first came to light in 2008,
in which bankers at various financial institutions manipulated
LIBOR for profit.
LIBOR is primarily used within finance documents as the rate of
interest which is applicable in an event of late
payment. It is also used in a wider range of agreements
– for example within construction contracts and operation and
maintenance contracts. As a result, a number of longer-term
projects with terms extending beyond the FCA deadline in 2021 will
need to consider the impact of the potential cessation of LIBOR on
their contractual arrangements. Industry bodies are therefore
strongly encouraging lenders and borrowers to prepare for the
transition as soon as possible.
The cessation of LIBOR beyond 2021 will therefore impact on both
new and existing contractual arrangements:
New contracts:
A number of new benchmarks have been proposed as alternatives to
interbank offered rates, known as risk-free reference rates. One
example of an alternative to LIBOR is the Sterling Overnight Index
Average ('SONIA'). SONIA reflects the
average interest rate which banks will
pay to borrow sterling overnight
from other banks. This rate has already been rolled out to an
extent in the UK, with Natwest announcing in June 2019 that they
were the first UK bank to trial a SONIA-based loan product.
However, SONIA is yet to gain full momentum in new financing
arrangements and, as a result, banks are continuing to use LIBOR as
the default rate within such financing contracts. However, given
the inherent uncertainty with the timing of the cessation of LIBOR
and additionally the preferred replacement rate for LIBOR, lenders
are relying in 'fallback' provisions within facility
arrangements to cater for amendments when LIBOR is no longer in
use.
However where agreement cannot be reached on lenders
unilaterally nominating a replacement rate of interest, parties are
increasingly using a procedural mechanism within the agreement to
decide on a replacement rate for LIBOR. This includes mutual
agreement, a formally designated replacement rate for LIBOR or
where neither is applicable, an independent decision by a body such
as the government.
Existing contracts:
A number of existing longer-term contracts, in place prior to
the FCA decision in 2017, may not contemplate the cessation of
LIBOR, and we would recommend a review is carried out of these
arrangements to determine what rate is applicable post-LIBOR.
Parties may wish to adopt a 'wait and see' approach, to
find out which rate is to be formally designated as the replacement
for LIBOR. Alternatively, parties may wish to address their
existing arrangements to come to a mutual agreement with the
counterparty on the replacement rate for LIBOR.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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