The United Kingdom’s Financial Conduct Authority (FCA) announced that the 1-month, 3-month and 6-month dollar LIBOR rate will cease to be published after June 30th, 2023. As a result of this announcement, both creditors and debtors and financial authorities have rushed to stop using these rates in financial transactions and to replace the LIBOR rate on consumer loans such as mortgage contracts. Is your company prepared for the end of the LIBOR rate?
Here you can find recommendations for the replacement of the LIBOR rate, which will help financial institutions, businesses, or creditors to be prepared for this transition.
- Measure your exposure
The first thing you should do is to identify the exposure of your current portfolio in response to the end of the LIBOR rate. To do this, you have to consider these three aspects:
- How many and which credit operations use the LIBOR rate and expire after June 30th, 2023?
- Do the contracts for these operations provide a replacement rate in case the LIBOR rate disappears?
- What type of debtor (or creditor) is the counterparty in those contracts? Is it considered as a consumer or a merchant?
When having a clear statement of your current portfolio (legacy contracts) you will be able to establish a better plan of action.
- Analyze and select a replacement rate
The LIBOR rate is one of the most used in the world for operations in dollars, but with its transition, do you know which rate to use?
Several working groups of financial institutions, companies and regulators around the world have proposed replacement rates such as the SOFR rate for dollars, the SONIA rate for pounds sterling, and the ESTR rate for euros, but also companies such as Bloomberg have created their own reference rates. In Costa Rica, for example, the TRI rate (Interbank Reference Rate or Tasa de Referencia Interbancaria in Spanish) is a local rate created by the Chamber of Banks and Financial Institutions of Costa Rica.
In order to choose one, you should analyze the different rates available, assess their reception in the market and in your business sector. Also, consider that it is a robust rate that meets the requirements in local regulations.
- Include a fallback clause in contracts
It was unlikely that anyone could have imagined that the LIBOR rate would disappear several decades ago when its use became popular, and many contracts do not consider a replacement rate or a mechanism to replace the rate in case it comes to an end. Therefore, it is recommended to include interest rate replacement clauses in new and legacy contracts. We recommend that this clause be as a “waterfall” and consider several triggers for its application.
- Consider operational matters
Finally, always keep in mind the operational matters necessary to make the transition possible. The transition from one rate to another at your internal systems can be more complicated than it sounds, you should even consider whether you should hire a new provider for the new rate you will use.
Andrés Alvarez Quesada