Reports of LIBOR’s Death Are Not Greatly Exaggerated

August 2017

On July 27, 2017, the UK’s Financial Conduct Authority announced that it plans to phase out LIBOR by 2021. Because LIBOR is a widely-used interest rate index in financial documents and commercial agreements, newly drafted contracts will need to take the phase-out into account, and existing contracts might need to be amended.

What is LIBOR?

LIBOR, or the London Interbank Offered Rate, is an interest rate to borrow money over a specified period (ranging from overnight to one year) set by several leading London banks. Each bank estimates the interest rates it would be charged to borrow money from another bank for the applicable period, and the average of those estimates is compiled and published daily. Because LIBOR is regularly maintained and published and covers several loan periods, it has become the interest rate index of choice in many commercial finance documents (including public finance documents) and other commercial documents such as preferred stock instruments.

Why is LIBOR being Phased Out?

Recent lawsuits alleging the “rigging” of LIBOR by certain London banks, combined with a relatively thin market in inter-bank loans, have convinced regulators that the current LIBOR rate setting mechanism is unsustainable. To lessen market disruption, the Financial Conduct Authority is allowing market participants several years to transition from LIBOR to one or more new interest rate indexes before LIBOR is no longer supported.

What will Replace LIBOR?

At this time, it is unclear what index, or combination of indexes, will replace LIBOR. One possibility is SONIA, or the Sterling Overnight Index Average, administered by the Bank of England. SONIA is based on trades in the UK overnight unsecured lending market. The U.S. Federal Reserve is also developing an index based on the cost to borrow cash secured by U.S. treasuries. The Securities Industry and Financial Markets Association maintains the SIFMA Municipal Swap Index which might be appropriate in certain public finance transactions. We expect that a market consensus on one or more favored replacement indexes will develop in the next few months.

What Actions Should be Taken Now?

We are advising clients to identify any documents that contain LIBOR provisions. Each of these documents will need to be reviewed by counsel and might need to be modified prior to 2021. Any ongoing negotiations with lenders or market participants for new transactions that involve LIBOR terms that potentially extend beyond 2021 should take into account the LIBOR phase-out, either by substituting a different interest rate index or by adding a replacement index to be used when LIBOR is no longer available. Some loan documents already contain “savings” language to provide that a different, comparable index reasonably selected by the lender will apply if the LIBOR rate is not available. However, given the importance of the interest rate in any credit transaction, most parties will not want to rely on this open-ended language.