The phaseout of the London interbank offered rate (Libor) will be complete at the end of the month, but some companies have not switched to any of the available alternatives, The Wall Street Journal reported.
Those companies that have yet to complete their transition—more than half, according to Amol Dhargalkar, managing partner and global head of corporates at Chatham Financial, a financial-risk adviser—could incur operational risks and potentially higher borrowing costs.
The Libor was the benchmark interest rate most widely used by financial institutions when making short-term loans to each other in the international market. It serves as a globally accepted key benchmark interest rate that indicates how much it costs to the banks to borrow from each other. However, the rate became suspect during the 2007-2008 financial crisis, when it was found that, for years, currency brokers at major banks had been coordinating with each other over instant messaging to fix the rates in order to boost profits and obscure financial difficulties. The scandal rocked the Libor's previously sterling reputation as a reliable rate. In the wake of the scandal, the United Kingdom's Financial Conduct Authority, its chief financial regulator, said that the rate is no longer tenable and so would phase out its use by 2021.
Most U.S. businesses that have made the switch have selected a version of the Secured Overnight Financing Rate (SOFR), U.S. regulators’ preferred alternative to Libor. Others have opted for the Bloomberg Short-Term Bank Yield Index, known as BSBY, or American Financial Exchange’s Ameribor.
But even those who have switched from Libor may still encounter difficulties. Term SOFR, a popular longer-term version of SOFR continues to cost more to hedge than the alternatives due to restrictions on banks, but not enough to dissuade companies from using it, according to the Journal.
Some companies that have arranged an automatic fallback to SOFR after Libor’s phaseout have put off upgrading their IT systems in favor of addressing other priorities such as inflation, Chatham Financial’s Dhargalkar told the Journal. But companies also might not have the same fallback language for their debt and derivatives, raising other operational risks. “Those operational considerations are real for both debt and derivatives in that they fall back to something that companies’ processes and systems don’t currently support,” he said.
Finance executives need to have protocols and reporting processes in place so they can look at their portfolios and readily determine the value of their financial contracts, William Wagner, partner at law firm Venable, told the Journal. “This is a lot more than just simply updating programming,” he said.
More than 8 percent of outstanding U.S. leveraged loans tied to Libor have no successor listed as of May 30, down from 10.9 percent a year earlier, the Journal reported.
Synthetic Libor, a key safety net permitted by U.S. regulators, has its drawbacks, corporate advisers told the Journal. In addition to synthetic Libor, certain companies can retain Libor longer by rolling over existing Libor-linked loans for as long as 12 months just before the phaseout.
David Ridley, a partner in White & Case’s debt-finance practice, told the Journal that a number of his clients are considering a rollover, particularly if they are unable to reach agreements with their lenders on loan-amendment terms.
The Alternative Reference Rates Committee (ARRC), a group of financial firms handling the U.S. phaseout of Libor alongside the Federal Reserve Bank of New York, recently urged companies and other market participants to complete their transition.
“These are choices that individual market participants can make, but eventually they will have to deal with this,” Tom Wipf, chairman of the ARRC and vice chairman of institutional securities at Morgan Stanley, told the Journal in referring to companies’ potential Libor extensions. “This is maybe the last round of can kicking.”