January 1, 2022, is the date when LIBOR—the acronym for the London Interbank Offered Rate, the most widely-used reference interest rate in the world— will officially be retired. LIBOR is referenced in $370 trillion worth of financial products, $200 trillion of which are in US dollars. “It’s not an understatement to call LIBOR the world’s most important number,” says Adam Nguyen, Co-Founder of eBrevia, a DFIN company and leading enterprise contract analysis software provider.
Without LIBOR, companies will need to renegotiate and/or amend a slew of contracts and financial documents. “The volume of work is staggering,” Nguyen told participants at DFIN’s July 14, 2020, webinar “LIBOR Transition: Lessons Learned and Strategies Going Forward.”
The decision to retire LIBOR was made by financial regulators in 2017, after a rate-fixing scandal a few years earlier. The problem with LIBOR, according to the regulators, is that its rates are determined by a panel of banks that base those rates on the price at which they would lend to one another. In contrast, the alternative risk-free rates (RFRs) that are emerging to take LIBOR’s place will be based on actual transactions. Sally Neal, Retired Partner at PwC and a speaker at DFIN’s July webinar, says that this makes manipulation less likely. Davide Barzilai, another webinar speaker and a partner at Norton Rose Fulbright in London, agrees, noting “These [alternative] rates are not reliant on people’s discretion and judgement so they should be free of manipulation.”
As companies prepare to navigate a post-LIBOR world, here are some important steps to take:
- Use AI to review fallback clauses. Artificial intelligence can be used to review fallback clauses, or clauses that spell out what would happen in the event that LIBOR was unavailable. Often fallback language was designed for situations in which LIBOR was temporarily unavailable rather than retired permanently.
- Understand which contracts are based on LIBOR and create a remediation strategy. Transitioning away from LIBOR may mean closing out contracts or generating amendments to existing contracts, often using standardized language. The degree of complexity will depend on the volume of contracts (some companies have hundreds of thousands of documents referencing LIBOR), the types of fallback language used, and the number of geographic markets in which a company operates.
- Get started. Norton Rose’s Barzilai has found that the greatest area of difficulty is sorting documentation and getting it ready for the LIBOR transition. Nguyen agrees, adding: “If you haven’t started, the takeaway is to start now.”
- Explore how technology can help you identify, organize, and update large volumes of contracts. Neal considers navigating the LIBOR transition “as much a data management exercise as a legal exercise.” For this reason, companies that use various software and artificial intelligence solutions like eBrevia to flag documents for remediation can save time and money. Neal points out that technology can filter out documents that do not reference LIBOR and extract relevant data from those that do, as well as locate those contracts that mature before December 31, 2021, without an extension provision.
- Research RFRs. LIBOR is issued in five currencies (US dollars, euros, Japanese yen, British pounds, and Swiss francs) and each currency will have its own alternative rate selected by the national banks from that jurisdiction. Two popular options are the UK’s SONIA (Sterling Overnight Interbank Average Rate), which is over 20 years old, and the US’s SOFR (Secured Overnight Financing Rate), which dates back to 2017. Companies also need to consider whether they will use a forward- or backward-looking rate for future transactions.
- Keep abreast of regulatory actions. Although certain interim dates for aspects of the LIBOR transition have been extended because of disruption from COVID-19, Barzilai is convinced that the final LIBOR deadline will not budge. Experts from DFIN’s webinar agree – and so to the extent possible, companies should stop using LIBOR and should plan for LIBOR to be completely retired at the end of 2021.
- Shore up your transition team. Some companies are doing the LIBOR review internally; others are using law firms and other service providers to make the process easier. Whatever your plan, a successful LIBOR transition takes a balance of competencies from legal to operations, technology, and individuals with specialized LIBOR expertise.
- Be realistic about the project’s scope and budget. It’s easy to misjudge just how many functions and resources will need to be involved in document and contract remediation for the LIBOR transition. Good project management can make the whole endeavor more cost effective. Too often, observes Barzilai, “the extent of operations that have to go into LIBOR transition is underestimated.”
- Use the LIBOR transition to investigate the latest technologies. “Digitization, especially for legal contracts, is, in my opinion, the wave of the future,” says Neal. While the LIBOR transition will require time, effort, coordination, and an ample budget, it’s also “a fantastic opportunity to get your institution… more educated and excited about the use of artificial-intelligence technology.”