LIBOR, the reference rate for determining interest on over $200 trillion of financings worldwide, terminates on December 31, 2021. How will interest be determined after that?
On July 12, 2019, the SEC Staff published a major and unusual joint statement on “LIBOR Transition.” The Divisions of Corporation Finance, Investment Management, and Trading and Markets, together with the Office of the Chief Accountant, issued a seven-page, single-spaced statement.
That statement notes:
The expected discontinuation of LIBOR could have a significant impact on the financial markets and may present a material risk for certain market participants, including public companies, investment advisers, investment companies and broker-dealers.
The SEC Staff then goes on to stress the importance of “… the work necessary to effect an orderly transition to an alternative reference rate…” [emphasis added]. The statement adds, “[t]he Commission does not endorse the use of any particular reference rates, noting that the Alternative Reference Rate Committee (“ARRC”) prefers the Standard Overnight Financing Rate (“SOFR”), but some market participants are also considering other U.S. dollar reference rates for certain instruments.” See my blog “Measure for Measure: LIBOR, SOFR, and the U.S. Dollar ICE Bank Yield Index.”
The SEC Statement does not directly address the impact of the end of LIBOR on other than U.S. capital markets, but the concerns raised by the Staff apply equally to non-U.S. public companies whose shares or American Depository Receipts are traded on U.S. equity markets. Moreover, the end of LIBOR has potential material consequences for public companies listed on exchanges in London, Paris, Frankfurt, Tokyo, Singapore, Hong Kong, and elsewhere.
In addition, the transition from LIBOR in global capital markets may involve switching to a reference rate other than SOFR, which will add to the complexity of financial disclosures.
The Staff then identifies particular areas to which affected market participants should give attention:
After noting that parties to a contract may disagree about how to handle the discontinuance of LIBOR (noting as an example that a floating rate obligation might become a fixed-rate one), the Staff poses six questions:
All new contracts extending past 2021 should have an alternative reference rate built into them. The Staff notes the availability of fallback language recommended by ARRC that is intended to function when LIBOR ends. The Staff also draws attention to the ongoing industry effort led by the International Swaps and Derivatives Association to implement “robust fallback language for derivative contracts.” See also my blog “Oh How Will We Measure When the Ruler is Uncertain: More Observations on the LIBOR Saga.”
The Staff urges market participants to “identify, evaluate, and mitigate” other risks, such as those affecting strategy, products, processes, and information systems – noting as an example that participants should be certain that their information technology systems can deal with new instruments, reference ratio, conversions, and hedges.
So it may be safely said that the way in which things, especially financial things, are measured is material. Hence, the SEC calls those affected by the end of LIBOR to account.
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