What Banks Should Consider for a Possible Discontinuation of LIBOR
The London Interbank Offering Rate (LIBOR) was first published in the 1980s to create uniformity in the growing market for interest rate swaps. In 2012, several banks and market regulators brought actions against many of the world’s largest banks for manipulating and conspiring to manipulate the rate. LIBOR may be discontinued in 2021 because the Financial Conduct Authority in the United Kingdom will no longer require banks to report the interbank transactions that are used to calculate LIBOR.
The Alternative Reference Rates Committee (ARRC) is a group of private-market participants assembled by the Federal Reserve Board and the New York Fed to help ensure a smooth transition from LIBOR to a more robust reference rate. The ARRC recommends using the Secured Overnight Financing Rate (SOFR) as a possible replacement rate. SOFR is a Treasuries repo financing rate and is published by the Federal Reserve Bank of New York daily. The SOFR rate was initially published in April 2018, and the relationship between SOFR, LIBOR, and the federal funds rate has been very close. Since SOFR is a risk-free rate and LIBOR is a risk-based rate, a spread adjustment will likely be required (generally around 20-25 bps). To provide some additional measures of the SOFR rate, the Federal Reserve Bank of New York will begin publishing the SOFR rate compounded averages over 30, 90, and 180 days starting the first half of 2020.
The Independent Community Bankers of America encourages banks to identify their assets and liabilities tied to LIBOR. Banks should consider developing standard replacement rate terms to include in their loan documents when originated, renewed, or modified. Banks may also want to develop language in their loan documentation that would permit the transit to SOFR, or another alternative rate such as the Prime rate, if LIBOR is discontinued or at a determined timeframe whether or not LIBOR is discontinued.