Is Your Business Exposed to LIBOR?

Peter D. Antonoplos

Washington D.C., September 2, 2019 – If your business is involved with other enterprises which hold debt or your business carries or is looking to take on debt for growth, the London Interbank Offered Rate (LIBOR) is of vital interest.  LIBOR has been the standard index for a variety of financial products since the early 1980s. 

LIBOR has been prone to manipulation scandals through bankers or other actors within the financial industry that have sought to artificially lower interest rates to increase traffic and revenue.  While these claims surfaced in 2012, regulators just recently announced that what is often referred to as the “world’s most important number,” propped up by an estimated $350 trillion in contracts globally, will be completely scrapped and replaced by 2021. 

This article focuses on market recommendations for a replacement benchmark interest rate from a group of private-market participants called the Alternative Reference Rates Committee (ARRC).  The ARRC’s main goal is to ensure a successful and smooth transition away from LIBOR for both national and international banks and borrowers.

SOFR the Savior

The Secured Overnight Financing Rate (SOFR) has been coined by the ARRC as the preferred alternative benchmark rate for U.S. dollar transactions. SOFR uses broad measures to calculate the cost of borrowing cash overnight, all of which is collateralized by U.S. Treasury securities in the repurchase market.  This index not only represents a nearly risk-free rate of borrowing.  However, it is also more accurate, stable, and representative of the U.S. economy.  Finally, SOFR is published each day at 8 a.m. ET by the Federal Reserve Bank of New York.

A major issue with LIBOR that has recently popped up is that the flow rate of currency within the index is small, mostly hidden from public view, and handled exclusively by major global banks. The opposite is true for SOFR which takes advantage of the large range of observable transactions that underlie the marker.  Throughout a given business day, SOFR will value between $700 billion and $800 billion in goods while regularly exceeding $1 trillion.  This characteristic helps to make this index transparent and representative of the current market across a broad range of participants, which helps to combat the manipulation that LIBOR constantly struggled with.

Though this index has multiple accessible benefits to those outside the financial industry, many difficulties remain on the road to total SOFR implementation. In most existing contracts, the fallback rate if LIBOR were to stop working is the prime interest rate. This rate is only given to the most creditworthy customers and is still consistently more expensive for borrowers than LIBOR.  Another issue that must be solved is that in transactions with more than one signee, changes to the interest rate typically require the consent of every debt holder which furthers the issues associated with altering current loans to the SOFR index. Finally, as SOFR offers lower interest rates then LIBOR, loans that do find a way to make the switch to SOFR will require an interest rate adjustment in order to keep loan costs comparable to those using LIBOR.

Industry Advice

The aforementioned ARRC has advocated two approaches to dealing with the issues present from the LIBOR transition to SOFR concerning loans. The first term coined is the “amendment approach.”  This path offers a streamlined process for future amendments that would be agreed to in advance in order to replace the existing LIBOR agreements. The second option available to consumers is called the “hardwired approach.”  Consistent with the approach commonly used in other cash asset classes, this proposal states that SOFR with an adjusted spread would replace LIBOR at an agreed upon date. Though the amendment approach is currently most common, the hardwired approach is beneficial and thus likely to gain traction as banks push to avoid the impending disaster that will occur after the loss of LIBOR.

The event that would trigger either approach consists of two possible occurrences.  First, an announcement from the benchmark administrator or the administrator’s regulator that states it has or will cease to provide the benchmark permanently.  The second opportunity would come from a public statement from the administrator’s regulator saying that the benchmark is no longer representative. Once one of these events came to fruition, the discussed fallback language would consequently spring into action.

If the amendment approach was chosen, the borrower and the administrative agent would select a spread adjustment that gives explicit consideration to relevant market conventions and governmental organizations. However, this selection can be overridden if a majority of lenders step forward and object. Further, if no party objects to the proposal within five days, the chosen rate and spread will be automatically implemented. Finally, in a small minority of loans, either no lender consent would be required for the amendment or a majority of lenders would be required approve the additional provision.

Concerning the hardwired approach, the options would be to first, replace LIBOR with a forward-looking term SOFR (the predicted future SOFR rate), and next take the compounded daily average SOFR present within in each case plus a spread adjustment. If neither of these rates would be optional, the hardwired approach would digress to the amendment process. Going off a government body, the spread adjustment would be selected and if this option is unavailable, the spread adjustment used by the International Swaps and Derivatives Association (ISDA) would instead be applied.  This measure has historic merit as being the median/mean of SOFR versus LIBOR.

Urgent Action

The transition from LIBOR to another index rate has been a topic of discussion for almost ten years yet has ramped up as time as gone on. The issue has come to the forefront of concerns for the U.S. Securities and Exchange Commission’s Division of Corporate Finance, Division of Investment Management, Division of Trading and Markets, and Office of the Chief Accountant (the Divisions) which issued a public statement concerning the transition from LIBOR on July 12, 2019.  In their statement, the organizations stated “risks associated with this discontinuation and transition will be exacerbated if the work necessary to effect an orderly transition to an alternative reference rate is not completed in a timely manner,” and warned that “the Commission staff is actively monitoring the extent to which market participants are identifying and addressing these risks.” However, during the conference hosted by the Securities Industry and Financial Markets Association on July 15, 2019, Federal Reserve Bank of New York President Williams requested more urgency from market participants in replacing LIBOR.

Six Steps to Prepare Your Business

In touch business leaders will understand the risk associated with the regression of LIBOR and take the necessary steps to mitigate potential risks. Listed are six steps to prepare your business for success after the end of LIBOR.

1. Assign responsibility. Forming a committee consisting of senior management will help address the issue and better the transition away from LIBOR.

2. Take inventory. Review current contracts to identify (a) where there is exposure to LIBOR, (b) what the fallback provision is (if any) for the scenario where LIBOR becomes unavailable and (c) how amendments to the benchmark interest rate are handled.  Limiting this inquiry to encompass only third-party debt instruments is a major mistake. Intercompany loans, long-term leases and procurement contracts may have a component within the contract that contains LIBOR.  Finally, It is helpful to flag agreements that are exposed to LIBOR that do not extend beyond 2021 in instance these agreements are extended after the extinction of the maker. 

3. Identify and mitigate any other potential consequences. Track the use of LIBOR present in your circumstances and identify potential consequences LIBOR may have on the transition on your products, operations, information systems or otherwise. Lastly, if you are a public company, you should consider the disclosure obligations present within your contract and decide whether any changes should be made to risk management policies, including the establishment of a task force.

4. Educate internal stakeholders. Educate all key stakeholders within the business (treasury, tax, legal, procurement teams, etc.) to ensure that relevant business implications are dealt with appropriately and in a timely manner. Make sure all team members with signatory authority for new agreements are considering this issue with all new contracts and emphasize the effective fallback language.

5. Stay current on market and regulatory developments. Watch for articles in the press and sign up for a “Secured Overnight Funding Rate” Google alert to monitor the web for applicable content. Also consider keeping tabs on the industry groups that are tackling the details of the transition:

a. Sign up for email alerts from the ARRC, the key group of decision makers guiding the transition from LIBOR to SOFR.

b. Find current guidance from the ISDA on fallback language for swaps and derivative contracts.

c. Get more detailed LIBOR transition news, market trends and resources as they relate to syndicated business loans from The Loan Syndications and Trading Association.

D. Keep informed of any relevant FASB Accounting Standards Updates for any changes relating to your financial reporting.

6. Engage counterparties. In order to lesson potential risks associated with the transition, reach out to your legal counsel or directly to counterparties to discuss the amendment process.

The Antonoplos & Associates financial services branch provides our diverse base of banking clients with a comprehensive range of solutions for LIBOR loan related legal issues. Our LIBOR practice provides the banking industry with over twenty years of client focused practice in title litigation, loan modification, title curation and equitable subrogation resolutions in connection with loan portfolios.  By striving to holistically understand the issues that our clients face, our financial services attorneys’ are able to provide forward thinking loan documentation and amendments through title curative actions including the correction of legal description errors, resolution by judicial action, equitable subrogation, and securing releases of prior liens, mortgages, and deeds of trust while also prescribing remedies for corrections to promissory notes and deeds of trust. 

Antonoplos & Associates financial services lawyers routinely litigate equitable subrogation matters on behalf of nationally and locally chartered banks. Our clients include mortgage lenders, mortgage servicers, banks, banking associations, and other financial institutions including the title insurance industry. Overall, our LIBOR attorneys’ have extensive experience representing loan portfolios and managing mutli-jurisdiction loan modifications and litigation for clients located within the financial services industry.
Peter D. Antonoplos, Esq.Partner
Antonoplos & Associates, Attorneys At Law
1725 Desales Street, N.W.Suite 600,
Washington, D.C. 20036
Fax:    (202)-803-5677
Email: Peter@