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The UK’s Financial Conduct Authority (FCA) has made it clear that the publication of LIBOR, the London Interbank Offered Rate, is not guaranteed beyond 2021. LIBOR, a benchmark interest rate at which major global banks lend to one another in the interbank market, is underpinning over $200 trillion USD of financial contracts. With the pending end to LIBOR as an interest rate index, financial institutions and individuals or entities with loans that could be impacted need to understand what this change means in order to limit disruption and mitigate risk.
LIBOR has been used globally as a benchmark to gauge funding costs and investment returns for financial contracts for more than 3 decades. It is used to help set the interest rates on many loans, swaps, bonds, credit cards, adjustable rate mortgages, and other products offered by financial institutions.
Changing industry norms and LIBOR manipulation scandals are driving a shift away from LIBOR, causing interbank lending markets to become much thinner and the number of actual transactions upon which the rate is based to decrease significantly. That has caused regulators globally to actively advocate that markets move away from LIBOR to a more reliable index.
PNC has a large team dedicated to this transition that is active in many industry working groups and closely engaged with market activities. No action is required of clients at this time. PNC will provide further updates and new documents or amendments to existing documents to facilitate the transition as replacement reference rates are identified and implemented in the financial industry generally.
Neither the industry nor PNC has found a perfect replacement for LIBOR. While certain rates receive many of the headlines, additional alternatives are still being considered.
The Alternative Reference Rates Committee (ARRC), an industry group convened by the Federal Reserve Board and the New York Fed, recommends using the Secured Overnight Financing Rate (SOFR). SOFR is considered a more robust reference rate than LIBOR as it is wholly based on actual transactions and represents an active daily market (over $750B in transactions).
Although LIBOR and SOFR reflect short-term borrowing costs, they are calculated very differently:
Loan documentation generally provides that if LIBOR is no longer available, the interest rate will be based on the Prime Rate.
As an alternative to the Prime Rate if LIBOR is no longer available, loans originated more recently may include a detailed mechanism that allows the loan documents to be amended to incorporate a new reference rate to replace LIBOR, as well as spread and other adjustments to account for differences between LIBOR and the new reference rate. In selecting the new reference rate and any adjustments, due consideration will be given to (a) recommendations made by the Federal Reserve or other applicable governing bodies, or (b) evolving or then prevailing market conventions for determining a replacement rate.
Derivatives documentation does not provide for a fallback rate if LIBOR ceases; however, the industry is working on documentation and ISDA protocol improvements to address conversion of LIBOR loans and corresponding floating-to-fixed rate hedges. ISDA expects to publish recommendations later this year.
Working within the Federal Reserve System, the New York Fed implements monetary policy, supervises and regulates financial institutions and helps maintain the nation's payment system.
The information contained in this site is of a general nature and does not constitute the provision by PNC of investment, legal, tax, or accounting advice. Opinions expressed herein are subject to change without notice. The information was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy.
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