The end of Libor - What comes next?

London Interbank Offered Rate also commonly known as LIBOR, is a rate that is set daily by collating estimates from 18 global banks on the interest rates on different financial products. It is also used as an index to measure the fund rate across global banks which are operating across London.

Most of the transactions were being priced under Libor, such as taking a student loan for instance, when one applies for a loan the bank charges a 6-month LIBOR rate + 2%. Then the loan calculation would amount to 2.34%.

LIBOR has been used for nearly three decades and has faced many setbacks and scandals as in July 2012, banks manipulated the interest rates which resulted in Libor rates in order which further impacts the LIBOR Benchmark and many more.

The Federal Reserve and the New York Committee created the Alternative Reference Rates Committee (ARRC), and this committee set up a robust replacement for LIBOR known as Secured Overnight Financing Rate (SOFR) for various transactions.

Although LIBOR is at its end, the journey from LIBOR to SOFR will be accompanied by certain challenges:

SOFR is priced at a lower rate than LIBOR which means a direct transition leads to reduction in interest rate.

Many contracts used a forward-looking index such as LIBOR, the forward-looking rate of SOFR is still in development and the ARRC plans to publish the rate by end of 2021.

Any contracts which extend post the closure of LIBOR would face challenges such as backlash faced due to the end of LIBOR or would have to switch to another benchmark. This would further lead to extra costs and avoid litigation issues in the future.

So guys, are you ready for the transition from LIBOR to SOFR? If not, do consider the following points:

Check if your systems and applications can handle the transition

Have a look at your contracts and see if they can handle the current transition

Backup plan for impacted borrowers

Thank you.

Regards,

Charmin Monteiro,

Kautilya,

IBS Mumbai.