LIBOR update
The London Interbank Offered Rate (LIBOR), currently the benchmark interest rate most widely used in financial markets, will be discontinued by year-end 2021. This transition carries significant implications for commercial lending and internal corporate financing structures.
WHAT WILL REPLACE LIBOR?
The UK Financial Conduct Authority announced in 2017 that mandatory LIBOR submissions would end in December 2021, citing vulnerability to market manipulation. Central banks and regulatory bodies are developing alternative risk-free rates (RFRs) as replacements.
Proposed Alternative Rates by Currency
- CHF: SARON (Swiss Average Rate Overnight) via SIX Exchange
- EUR: €STR (Euro Short Term Rate) via European Central Bank
- GBP: SONIA (Sterling Overnight Index Average) via Bank of England
- JPY: TONA (Tokyo Overnight Average Rate) via Bank of Japan
- USD: SOFR (Secured Overnight Financing Rate) via Federal Reserve Bank of New York
HOW DO THESE RATES DIFFER FROM LIBOR?
These proposed rates offer greater stability than LIBOR due to larger volumes of underlying transactions. However, they present drawbacks: they operate on a backward-looking basis, lack multiple maturity options, and are set at different times across jurisdictions rather than uniformly at 11 a.m. London time.
IMPLICATIONS
Beyond commercial loans, LIBOR’s discontinuation will affect internal financing arrangements, including intra-group loans and cash pooling structures. Companies must amend legal agreements governing these arrangements, potentially requiring revised transfer pricing documentation. Treasury hedging strategies will also require reassessment.
THOUGHTS
Market participants are adopting the Loan Market Association’s stopgap language to facilitate smoother transitions to new rates. From a transfer pricing perspective, multinationals should conduct legacy transaction reviews, reduce LIBOR dependence in new agreements, incorporate LMA enabling provisions, and align treasury and tax functions around the replacement approach.