Effectively implementing any big change should start with a plan. Do you know what this plan should entail for LIBOR transition?
Preparing for the transition
The discontinuation of the London Interbank Offered Rate (LIBOR) will have far-reaching effects on contracts in the financial industry, ranging from standard loan contracts to complex derivatives and debt transactions. The first article in our LIBOR transition series discussed the background for this change and outlined steps banks might take to prepare.
While selecting and employing a replacement rate might sound simple, the transition from LIBOR will require a coordinated effort from multiple stakeholders. From contract identification to impact assessment and client experience management to status tracking, it is critical that institutions put a road map and project plan in place to prepare for the transition process.
What’s in a LIBOR transition plan?
Creating a transition plan might sound easy, but it quickly can turn from a dusting of snow to an avalanche as various components are revealed. On the surface, the task is simple: Replace references to LIBOR in contracts with an alternative rate before the index disappears. However, once institutions start to assess the hows and whats of transition, they quickly realize the many steps involved in this process.
One complicating factor of the LIBOR transition is that many institutions are considering a move to a risk-free rate such as a U.S. Treasury rate or a secured rate such as the Secured Overnight Financing Rate (SOFR), which contrasts with LIBOR as an unsecured rate incorporating the notion of credit risk. This component of transition expands the work required beyond a simple find-and-replace exercise, as the institution must understand the impact of this difference.
The Alternative Reference Rate Committee (ARRC) initially published its recommended best practices and timeline for completing the transition from LIBOR on May 27, 20201. ARRC updated its best practices in August 2020 to recommend adherence to the International Swaps and Derivatives Association’s Fallback Protocol for Interbank Offered Rates. ARRC issued another update in September 2020 to suggest including the ARRC-recommended (or substantially similar) hardwired or hedged LIBOR fallback language in new business loans as soon as possible, but no later than Oct. 31, 2020. While various industry publications suggest high level milestones, the detailed planning and execution falls upon institutions to determine the best way to accomplish the underlying tasks with their unique sets of employees, contracts, and customers.
Determining appropriate steps in a LIBOR transition plan can help organizations meet the looming deadline. Along with establishing key milestones, the plan should provide a detailed timeline and delineation of responsibilities. While the ARRC summarized 10 practical implementation steps for SOFR adoption in September 2019, these steps start with the assumption that SOFR has been selected as the alternative rate2. Institutions considering rates other than or in addition to SOFR might have additional work to do. Plans should include, at minimum, the following attributes (grouped by key stakeholder, not chronologically):
