What is Happening?
The UK regulator, the Financial Conduct Authority (FCA), has made clear that the continuation of LIBOR beyond the end of 2021 is uncertain. The current panel banks have agreed to continue to submit rates to calculate LIBOR until the end of 2021. Submitting banks now dislike doing this because of the potential liability that comes with it. So there is a risk that one or more submitting banks would wish to cease submitting rates when they can (i.e. from the start of 2022). If too many do this, then LIBOR will not be capable of being determined and published in the existing manner and publication may need to cease. This will then affect all the pre-existing transactions based on LIBOR. Of these, some currently have usable fallback arrangements, but many do not. One task is to ensure that new transactions have usable fallback arrangements.
Is There a Viable Replacement Rate?
For each of the five currencies -- dollars, Swiss francs, euro, sterling, yen -- a committee has been appointed to examine and consult with the relevant market to determine what rate is suitable for use in place of LIBOR and the results have one thing in common: All the proposals are markedly different from LIBOR, as they are all based on backward-looking overnight risk-free rates. It is not yet clear how best to bridge the gap between a risk-free rate and LIBOR in order to use the risk-free rate as a fallback to LIBOR.
If LIBOR Ceases to be Published, Will Contracts be Frustrated?
Many contracts have fall-back language that addresses or attempts to address circumstances in which LIBOR ceases. These may prove more or less useful. The size of the potential problem will diminish as the market adopts different benchmarks for new transactions. If there is a significantly large problem, then perhaps the continued publication (consensually or by compulsion) of the key LIBOR rates will be a solution, until the vast majority of existing trades have matured or transferred to alternative rates.
What Should Non-Banks Do To Prepare?
Non-banks should analyze their exposure to LIBOR, by currency and instrument, and determine a profile for that exposure by time. The derivatives markets and the cash markets may treat a cessation of LIBOR in different ways, so gross and net exposure in different markets may also be important. All market participants should consider using alternative rates for new transactions. Non-banks should also continue the dialogue with their financiers over (a) the proposals that the market is considering, (b) regulatory developments and timetables and (c) the development of trading and hedging products relating to alternative benchmarks and the basis risk between such benchmarks and LIBOR.
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