Libor is ending, and corporates need to know their options

Banks must speak to Main Street now if US Libor transition is to succeed, argue ARRC working group leaders

Main-Street-confusion-over-Libor-transition
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In the six months Libor has left, thousands of Main Street borrowers face a critically important choice: what rate to use in place of the outgoing benchmark?

As things stand, most borrowers are aware of the need to transition. Many have a preference for a replacement that is based upon the secured overnight financing rate, or SOFR – the officially endorsed successor to US dollar Libor – rather than one of the credit-sensitive alternatives that could see the cost of borrowing climb at times of stress. But the majority have not yet been approached by their banks to discuss the available options in detail, or to thrash out transition plans.

We call on banks to begin this process expeditiously by reaching out proactively to borrowers and working out a plan together. 

As members of the Alternative Reference Rates Committee (ARRC), the group of private-market participants convened to help ensure a successful transition from US dollar Libor to a more robust alternative reference rate – and leaders of its working group for non-financial corporates, which aims to prepare this sector of the market for transition – we feel strongly that considering and incorporating the perspective of borrowers is essential to ensuring a smooth switch away from Libor. It’s why we recently wrote a letter to key financial market regulators to explain this perspective, why it’s so important, and how we recommend factoring it into their thinking.

It is critical that Main Street borrowers – all the non-financial corporates and organisations holding contracts that still reference Libor – are enabled to transition smoothly. As we enter the final leg of this multi-year effort, non-financial corporates still face myriad issues and risks they will need to navigate – including not only the operational and legal complexities involved in switching contracts from Libor to an alternative rate, but potentially also delays in supplies and business operations, state and federal court cases, contracts without fallback provisions, and more. In short, it’s a daunting task to move new contracts away from Libor by the end of this year, even with the additional time that Libor’s regulator, the UK Financial Conduct Authority, recently granted that will allow many legacy contracts to wind down.

Most non-financial corporates now have a solid grasp of the transition at a high level. They know the cessation of Libor is coming, they know it could pose significant financial stability risks if not properly managed, and they know waiting until the last minute is not an option.

Missing detail

The very real problem at this late stage in the transition is that they don’t know what their options are for an alternative rate and what that means for ensuring the readiness of their internal compliance and technology systems.

In a March 2021 survey conducted with our working group’s members, a full two-thirds of respondents said they have not received detailed proposals or timelines for transition implementation from their bankers. While banks are facing their own considerable challenges in preparing for the transition, non-financial corporates need this important information now to be able to rework their contracts and their internal compliance and technology systems before new Libor contracts become unavailable. Non-financial corporates have the additional challenge of reviewing and amending their commercial contracts with suppliers and customers that often have Libor references to adjust for payment delays that occur in the normal course of business.

It’s critical that lenders proactively start conversations with their borrowers now – and that they talk corporates through their full range of options in selecting an alternative rate

A smooth Libor transition is especially important for small to medium-sized Main Street companies that have limited staffing and resources to handle these complex transition-related issues in tandem with their day-to-day business operations, especially while they’re trying to recover from the effects of Covid-19.

Ultimately, if Main Street borrowers are not fully ready for the adoption of SOFR, the ARRC’s preferred alternative to US dollar Libor, and if they don’t have a roadmap in place now that will guide them through transitioning all of their contracts away from the old benchmark, then borrowers and issuers could face disruptions and bear higher interest and financing costs. This could ultimately force cost-cutting elsewhere, including potential job cuts.

Against this backdrop, it’s critical that lenders proactively start conversations with their borrowers now – and that they talk corporates through their full range of options in selecting an alternative rate and preferably the ARRC-recommended risk-free rate using SOFR. Depending on the type of contract they hold – whether it’s a term loan, floating rate note, or asset securitisation – the borrower must carefully consider which form of SOFR is optimal. As we saw in the same survey of our members, 94% want to be offered a range of SOFR-based rate choices, including both in-arrears and in-advance options, and 88% want to borrow using alternatives based on SOFR rather than credit-sensitive rates that could move up – as Libor has done – in times of economic stress.

Banks, regulators, legislators, and industry groups must work together in the coming months to not only incorporate the borrowers’ perspective and priorities into Libor transition planning, but to also proactively find ways to educate non-financial corporates and help them chart a clear and informed roadmap toward SOFR. The success of the Libor transition depends on it.

About the authors

Deas, Hunt and Quaadman

The authors of this article lead the Non-Financial Corporates Working Group of the ARRC – the industry body convened by US regulators to support efforts to transition away from US dollar Libor. They are Tom Deas, National Association of Corporate Treasurers; Tom Hunt, Association for Financial Professionals; and Tom Quaadman, United States Chamber of Commerce.

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