While the Covid-19 crisis has caused great personal pain and ground businesses and governments to a halt, there’s one thing that shows no signs of stopping: The transition from Libor at the end of next year and the approximately $200 trillion in U.S. dollar Libor contracts that come along with it. And while 500 days may at first blush sound like ample time for a transition, it is actually getting quite late in the game. It is time to mobilize.
The swath of those impacted by Libor is vast. It is the commonly used index in setting many adjustable-rate loans worldwide—from corporate loans to mortgages to credit cards to auto loans to student loans in numerous countries.
But, in reality, the “interbank” lending market (the “ib” in Libor) barely exists anymore, and banks that provide submissions to create a Libor curve largely have to estimate what they think it is—and that makes them very uncomfortable. The U.K.’s Financial Conduct Authority (FCA) has gotten banks to agree to provide Libor submissions, but only through 2021. So, unless those banks announce that they will continue Libor submissions thereafter, we must assume that December 2021 is the drop-dead date. To do otherwise would be to invite a totally avoidable black swan into the loan business at a time when the global economy is on already shaky ground.
A number of people are waking up and taking the Dec. 31, 2021, deadline seriously. That’s great, but it’s not enough. Everybody needs to be up and at ‘em! If everyone plants their feet on the ground and executes with direction and determination, then what could be a great financial disruption will be avoided.
Fortunately, there are tools to manage this risk. The U.S. Federal Reserve has organized the Alternative Reference Rates Committee (ARRC), made up of public and private sector participants, that is charged with managing the U.S. Libor transition. It has a plan to get us off Libor and onto SOFR (the Secured Overnight Lending Rate) in one piece. Used together, these tools and date-based recommendations can help the loan market make it across the finish line.
New business loans should include hardwired U.S. Dollar Libor fallback language by Sept. 30, 2020. This hardwired language just means that a loan will automatically convert from Libor to SOFR, instead of undergoing a time-consuming amendment process. There are more than 10,000 U.S. dollar syndicated loans outstanding; quickly executing so many amendments to replace Libor when it ends would be challenging—even in a benign market. And there should be no presumption that the market will be benign when Libor ends.
Third-party technology and operations vendors should complete all necessary enhancements to support SOFR by Sept. 30, 2020. Lenders and borrowers must be confident that SOFR can be operationalized by Libor cessation as they begin using hardwired fallbacks. The ARRC Business Loans Working Group has worked for over a year with vendors and lenders to develop conventions and calculations to help update loan systems.
No business loans using U.S. Dollar Libor should be originated after June 30, 2021. This is just six months before the potential end of Libor. At that point, it seems wildly inadvisable to add still more deals to the loan backlog that must convert from Libor.
For business loans specifying that a party will select a replacement rate for U.S. dollar Libor at their discretion, that party should disclose to relevant parties the replacement rate they anticipate selecting at least six months prior to when it would become effective. Granted, that’s a mouthful, but lenders and borrowers will need to prepare to transition their loans and uncertainty around the replacement rate makes a challenging process that much harder.
For all of us in the loan industry, contemplating Libor cessation is daunting. Like an onion, there are many layers—and once one layer is peeled, another one emerges. It is tempting to pull the covers over your head and hope it all goes away. But it is not going away, and the only way to succeed is to buckle down and do the work. The tools are now here to make it through the transition and the alarm is ringing.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Meredith Coffey is executive vice president at the Loan Syndications & Trading Association in New York where she runs the research department and co-heads the LSTA’s public policy initiatives, which help facilitate continued availability of credit and the efficiency of the loan market. She is also a member of the Alternative Reference Rates Committee.