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With parallels to Brexit, it is virtually impossible to be in the financial services industry in the UK and ignore the regular updates and messaging coming from the Prudential Regulation Authority (PRA), Financial Conduct Authority (FCA), the Bank of England, the working group on risk free rates and the ever gathering snowball of articles and materials from the professionals in the market.
Ignorance is bliss?
Most if not all firms either headquartered or operating in the UK have an awareness of the implications of LIBOR’s imminent demise, ranging from reasonably aware and taking some initial steps to in-depth knowledge and well advanced in transition planning. However, there are many international banks (some of which will have branch offices in the UK) who have not yet appreciated the challenges which the end of LIBOR poses, or started thinking about the steps required in advance of 31 December 2021. In some cases, the branch offices in the UK and elsewhere can see the risks ahead but head office may not have given it the attention it deserves.
For any banks adopting this kind of “head in the sand” approach, the message has to be: get up to speed quickly and understand how the end of LIBOR will impact on the business as a whole.
Is a wait and see approach defensible?
Perhaps the lack of engagement in some quarters is not attributable to a lack of awareness, but instead to an expectation that the market, regulators, government or a combination of all of these will step in and produce a workaround, which will avoid the need to tackle the issue when there are no doubt more pressing matters higher up the agenda. Of course, the UK regulators have been at pains to warn all firms that LIBOR will cease and that gambling on external forces solving the problem is not the right move.
Despite this and with the end of LIBOR still 2 years away, depending on the scale of the organisation, a “wait and see” strategy appears an understandable one to adopt; but it is not without risk.
The fact is that international banks have commonly used English law documents including LIBOR provisions (usually based on LMA or APLMA standards) for loans all over the world, even where there is no substantive connection with the UK. The effect of the end of LIBOR on those documents will be a matter of English law and it is vital that international banks understand the implications so that they can at the very least understand the risks associated with a “wait and see” policy. Head offices of international banks may not face the direct level of scrutiny of the UK/EU or US regulators that their branch offices face, but they cannot escape the need to understand and engage with the underlying challenges.
What are the challenges?
The implications of the end of a rate which underpins so many loans, as well as other financial products and contracts, is multi–faceted and listing them all would be a major undertaking. In terms of loans though, it is worth highlighting a select few:
There are many more challenges ahead. The dire warnings from regulators and commentators alike are undoubtedly well founded. The end of LIBOR presents a massive challenge to lenders and the market as a whole.
What should banks be doing?
The message from the UK regulator couldn’t be clearer: lenders should be taking steps now. In this context, most firms in the UK have been asked to produce details of their respective LIBOR exposure by 31 December 2019. A clear marker has also been put down that new LIBOR issuances should not be made after Q3 2020. Most LIBOR related articles culminate with the now-familiar warnings if immediate steps are not taken.
But how should international banks approach this? There is always the risk that a huge amount of time and costs is expended at a time when so much is unknown.
Lenders do appear to be in a difficult position. On the one hand they are being told that they should not anticipate that LIBOR will continue and that they should take immediate action to transition, but there is currently no “oven ready” infrastructure for RFRs to switch to. Term RFRs do still remain a possibility, but the leaders in the loan markets are a long way off blazing a trail to show how it should be done.
Faced with this, international banks, often with more modest resources, are quite understandably being cautious about expending time and effort now. The dire warnings do not necessarily apply to all lenders in the same way – how a firm reacts will depend on its size, location, the nature of the loans etc. Perhaps it is time therefore to differentiate between firms and how they should respond.
Taking steps does not necessarily mean launching into a massive re-papering exercise straight away. There are steps that can and should be taken sooner rather than later which do not necessarily involve incurring significant costs. Although the approach of each lender will be different, these should include the following:
There are many questions that currently remain unanswered. The FCA will likely continue its engagement with firms as the end of LIBOR draws closer, but it remains unclear to what extent they will provide additional guidance and support. What is clear, is that the FCA expect firms to start making decisions and implementing their LIBOR transition strategies now, in readiness for the significant impact this change is likely to have on the industry.
So far, the financial services industry has been holding its breath waiting for the outcome of Brexit negotiations, regulatory changes and the recent general election in the UK. However, it’s now essential for banks to take proactive steps to ready themselves, identify their LIBOR exposure, and implement smart solutions to minimise business disruption during the impending transition.
This article was first published by Global Banking & Finance Review.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at December 2019. Specific advice should be sought for specific cases. For more information see our terms and conditions.
19 December 2019
by Peter Carney