29 September 2020 - As you may be aware, LIBOR index rates - the global reference rate for unsecured short-term borrowing in the interbank market - will be decommissioned towards the end of 2021. The Secured Overnight Financing Rate (SOFR) will become the new short-term interest rate benchmark for USD-based financial markets after LIBOR is decommissioned, with other benchmarks introduced in different geographies.
However, SOFR is not a simple substitution for LIBOR. There is a range of complexities affecting the transition, which is the most substantial operational change to the credit markets in 40 years, as it will have an impact on derivative products, loan products, swaps, bonds and hedging.
Currently, both LIBOR, SOFR and other benchmarks such as SONIA (the Sterling Overnight Index Average) in the UK co-exist. Periodic advice on the LIBOR transition is being provided by the relevant regulatory authorities, such as the Alternative Reference Rates Committee (ARRC). We will be in contact with our client base with the relevant regulatory updates as they pertain to them.
We would like to take this opportunity to update you on how the Citco group of companies is preparing for this change. Our preparations are being led by Elaine Furnari, Head of Loan Services at Citco Fund Services (USA) Inc, who sits on a number of ARRC’s operational committees.
We are currently in the process of completing a systems-readiness check, involving the compilation of clear guidance on the LIBOR transition for our diverse client base. For now, we recommend clients take an inventory of contracts extending past 2021 that reference LIBOR and determine which terms need alteration, such as, but not limited to:
- Floating rate notes
- Syndicated loans
- Bilateral business loans
- ISDAs that maintain industry standard swap and derivative documentation
- Limited Partnership Agreements, or other offering/ fund documents as applicable, that reference LIBOR for incentive fee/performance fee allocation hurdle rate purposes, carried interest for preferred return purposes, and for certain close ended funds where LIBOR is used in subsequent-close interest calculations.
In addition, we suggest that you:
- Begin discussions with lenders and derivatives counterparties about fallback language in existing contracts, including selection of an ARR ("Alternative Risk Rates"), triggers for a switch to an ARR and calculation of a revised credit spread.
- Focus on direct and indirect exposures and on fallback language that is ambiguous or that addresses only the temporary unavailability of LIBOR.
- Be proactive in renegotiations with counterparties to address any contractual uncertainty. The ARRC has published recommended fallback language and this will be an important reference point.
- Identify, evaluate, and mitigate other consequences of the discontinuation of LIBOR, such as on strategy, products, processes, and information systems. For example, you may need to ensure that your information technology systems are able to incorporate new instruments, rates and calculation conventions with features that differ from LIBOR.
- Manage any resulting, necessary changes to systems and processes. An impact assessment of the discontinuation of LIBOR extends beyond identification, evaluation, and mitigation efforts related to existing or new contracts.
- Evaluate the impact of financial, operational, legal, regulatory, technology and other risks. We recommend that you examine your individual circumstances and consider any possible risks beyond those identified above.
At some point in the future, best practice will involve notifying your investors of the implications of moving from LIBOR, but we have yet to reach that stage. As described above, we will be compiling specific recommendations on the transition’s impact on specific asset classes and products, including loans and derivatives in the coming months.
In summary, we will be ready well in advance of the migration in 2021.
We appreciate our relationship with you. Should you have any further enquiries, do not hesitate to contact your relationship manager directly.
By Elaine Furnari, Head of Loan Servicing, Citco Fund Services (USA) Inc.