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It’s 2020 And It’s Time To Find LIBOR Fallbacks

It’s been two and a half years since the Financial Conduct Authority in the UK first announced the sunset of LIBOR. Since then, organizations have been slow to take action and find a reference rate alternative to LIBOR.

Mortgages, commercial credit agreements, securities, bonds, and a range of other financial instruments are all directly, or indirectly, linked to LIBOR. And though LIBOR may not disappear entirely, the FCA’s decision to stop requiring banks to submit LIBOR rates has left a vacuum. This is why we have diligently built the scope and capabilities of a LIBOR-centric data model for ContraxSuite. The goal is to make it faster and easier for organizations of all sizes to:

  • Find LIBOR-related clauses and figures in contracts
  • Extract that data and place it in a database
  • Identify ways to remediate “LIBOR-infected” contract language

Transition

U.S.-based organizations that don’t yet have a transition plan in place for their LIBOR-infected contracts risk being left behind by competitors. But there’s an even bigger reason for immediate transition: the deadline for having a plan in place is February 7th. The NY Fed has outlined steps all regulated institutions must take to assess their risk and report their plans. One aspect of a transition plan delineated by the NY Fed is that organizations should have “processes for analyzing and assessing alternative rates, and the potential associated benefits and risks of such rates both for the institution and its customers and counterparties.”

At this stage in the game, a tech tool becomes a vital addition to a LIBOR transition plan. For many, it could mean the difference between getting contracts renegotiated promptly, or paying fines due to incomplete plans.

The Latest

The market has taken the (rather big) hint. In England, banks have already taken strides toward replacing LIBOR with the Sterling Overnight Index Average (SONIA). In the U.S., the Alternative Reference Rates Committee has selected the Secured Overnight Financing Rate (SOFR) to fill the LIBOR void. It differs from LIBOR in several key ways:

“Repo market prices respond to changes in supply and demand. SOFR, which is based on actual transactions, reflects variability in actual market pricing. Unlike Libor, which has become increasingly based on estimates, SOFR accurately measures the market it was created to represent.”

Finding Fallbacks

To analyze and assess alternative rates like SOFR, you need to sift through contracts and find the fallback provisions. Let’s consider a hypothetical: you work at a large bank, and the bank’s transition plan calls for SOFR-based reference rates for all commercial loans and mortgages going forward. Now what?

If you’re lucky, you know where your contracts are stored. If you’re even luckier, a large portion of the bank’s contracts tied to LIBOR already contain a SOFR-based fallback provision. This solution doesn’t solve the whole problem, though. SOFR has only been published since April 2018, so the odds are good that your bank has loans older than SOFR’s first publication. This means that even under the best circumstances, many of the bank’s loans will rely on LIBOR as their primary reference rate, with no alternative rate included in fallback provisions.

SOFR is not nearly as ubiquitous as LIBOR yet. Nor, for that matter, is any other reference rate (hence the problem). But in addition to this, there is also more than one way to write a fallback provision. Some contracts contain fallbacks for an event when the LIBOR rate becomes unavailable, but usually the timespan for these fallbacks is short (a week, or even less). Other contracts contain fallback calculations that might be overly favorable to one party over the other(s). Still others may have a fallback rate tied to something like SOFR, but often only as a temporary solution, not a permanent one.

The ContraxSuite AI platform can help determine which kinds of fallbacks you’re dealing with. Many contracts, for example, have a fallback provision like the following:

LIBOR fallback provision language in a contract

Just one example of a Eurodollar (LIBOR) fallback in a loan contract

This is a common type of fallback in a syndicated loan, where an administrative agent has some flexibility to determine what to do if a Eurodollar rate (a.k.a. LIBOR rate) is unavailable. With a platform like ContraxSuite, you can find these sections of text within an entire corpus of contracts, and discover which fallback provision language occurs most commonly across that corpus. Having such a targeted search for fallbacks is a powerful component of any transition plan.

Conclusion

LIBOR is going away, and the deadline for transition plans is February 7th, 2020. You don’t have to have every contract analyzed and remediated by then, but you do need to know how that process will work for your organization. You need to able to answer the tough questions, soon.

You can’t find all of your LIBOR-infected contracts until you know where they are. And you can’t fully assess your risk exposure until you’ve found the fallbacks in all those contracts. The ContraxSuite AI platform is perfect for every step in this process. And the clock is ticking.

 

About Elevate

Elevate is a global law company, providing consulting, technology and services to law departments and law firms. The company’s team of lawyers, engineers, consultants and business experts extend and enable the resources and capabilities of customers worldwide. In November 2018, Elevate acquired LexPredict, the legal AI technology consultancy that created the ContraxSuite AI platform. Find out more at elevateservices.com

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