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Are You Ready for the LIBOR Phaseout?

December 16, 2021

The London Interbank Offered Rate, or LIBOR, reflects the interest rate that banks pay to borrow money from each other. It will soon be phased out — what does this mean for your business?

The London Interbank Offered Rate (LIBOR) was once the most common reference rate in the global financial markets. However, due to previous scandals, LIBOR will no longer be used as a benchmark interest rate. The cessation dates vary for rates used in the United States: Some LIBOR tenors will end by the end of 2021; others will continue to be published until June 30, 2023. The LIBOR phaseout affects any organization that has borrowed money through rate-referenced debt or has any agreement or contract that references LIBOR. What does this mean for businesses and nonprofits? We explore here.

What Is LIBOR?

Check out our blog, What You Should Know about the LIBOR Phaseout, but essentially, the London Interbank Offered Rate (LIBOR) is a global benchmark interest rate, calculated in five different currencies. It is being phased out due to a rigging scandal that came to light in 2012, revealing that some banks have been reporting artificially low or high interest rates to benefit their derivatives traders.

The one-day, one-month, three-month, six-month and one-year U.S. dollar (USD) LIBOR rates will cease publication on June 30, 2023. Meanwhile, the one- and two-week USD LIBOR rates will cease publication as of December 31, 2021, although a synthetic rate may be available for legacy contracts after this date. Despite the extra 18 months for certain LIBOR tenors, new loans and contracts may not utilize LIBOR after December 31, 2021.

What’s Replacing LIBOR?

Secured Overnight Financing Rate (SOFR) will replace LIBOR in many cases. Because SOFR uses data from observable transactions rather than estimated borrowing rates, it’s generally less susceptible to manipulation.

What Do Entities Need to Do To prepare?

Here are three steps borrowers should take to prepare for the phaseout:

1. Identify your incomplete LIBOR-based financial obligations. This includes any debt or contract that references LIBOR and has a maturity date that extends beyond the cessation date for the specific LIBOR tenor used. Tenor is the length of time remaining before a financial contract expires, in this case — overnight, one-week, one-month, two-month, three-month, six-month or twelve-month. Outstanding obligations may include municipal bonds, notes, bank loans and lines of credit, derivatives, leases, installment sales agreements, other credit facilities and certain investments.

2. Determine if your agreements include effective “fallback language.” This is language that indicates what rate your entity will fall back on once LIBOR becomes unusable. Existing agreements entered into prior to 2017 could include language designed for only a temporary termination of LIBOR as a reference rate so they would need to be amended. Amendments could include “spread adjustments” (a positive or negative addition to the applicable interest rate).

3. Analyze the fundamental differences between using LIBOR and the alternative reference rate. Counsel and your financial advisors can help you determine how the transition will go. You’ll need to factor in potential changes in interest rate levels, changing market conditions, state lending law constraints and how financial ratios, reporting, covenants and accounting practices will be impacted.

Have You Implemented the Changes Yet?

Many organizations haven’t yet addressed how they’ll transition away from LIBOR — and time is running out. Many contracts don’t have fallback language when LIBOR is no longer available, or they have fallback language that assumes LIBOR will be only temporarily unavailable.

Companies and nonprofit organizations could incur significant costs as they implement the changes, depending on the number of contracts involved. Last year, the Financial Accounting Standards Board (FASB) issued guidance that simplifies the transition from LIBOR. Accounting Standards Update (ASU) No. 2020-04, Reference Rate Reform: Facilitation of the Effects of Reference Rate Reform on Financial Reporting, provides:

  • Continuation of eligible contracts that are modified during the transition, eliminating the need to reassess or remeasure the contracts for accounting purposes,
  • Preservation of hedge accounting during the transition period, and
  • A one-time election to transfer or sell held-to-maturity debt securities that are affected by rate reform.

This guidance must be consistently applied to all contracts and hedging transactions that reference LIBOR. It was effective immediately and expires after December 31, 2022. It applied to private companies and nonprofits at the same time as public companies because the changes were driven by regulatory reform that’s outside of the FASB’s control.

Important: The FASB plans to meet either in December 2021 or January 2022 to discuss extending the sunset date for the accounting rules to align with the new LIBOR cessation date. No decisions have been made yet.

For More Information

We advise you to get started on your LIBOR transition protocol as soon as possible so you are in a good place to identify risks and potential challenges. Reach out to us at any time for guidance or assistance.

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