The phasing out of the London Interbank Offered Rate (LIBOR) at the end of 2021 and its replacement with Alternative Risk-Free rates (ARRs) will have far reaching consequences for financial institutions and borrowers. LIBOR is currently the benchmark reference rate for over $350 trillion financial contracts worldwide. Lenders use LIBOR as the benchmark reference for determining interest rates for various debt instruments and is also commonly used for other financial products such as derivatives including interest rate swaps or currency swaps.
Transition from LIBOR
Beyond 2021, the Financial Conduct Authority (FCA) will no longer guarantee the production of LIBOR and the ICE Benchmark Administration Limited (IBA), the authorized administrator of LIBOR, confirmed its intention to cease the publication of the following reference rates:
| Reference rate | Tenors | Cessation of publication |
| EUR LIBOR | All | December 31, 2021 |
| CHF LIBOR | All | December 31, 2021 |
| JPY LIBOR | All | December 31, 2021 |
| GBP LIBOR | All | December 31, 2021 |
| USD LIBOR | One week and two-month | December 31, 2021 |
| USD LIBOR | All other tenors (e.g., overnight, one month, three-month, six-month and twelve-month | June 30, 2023 |
However, the IBA will publish the one month, three-month and six-month sterling and Japanese yen LIBOR settings under a “synthetic” methodology for the duration of 2022 to help ensure a steady wind down and will only be available for use with legacy contracts. The FCA has noted that any settings published under the “synthetic” methodology will no longer be representative of the underlying market or economic reality the setting is intended to measure.
Accounting implications of the reform
The reform of LIBOR and other Interbank Offered Rates has resulted in financial reporting requirements and the International Accounting Standards Board (IASB) tackled this reform in two phases:
- Phase 1
Amended specific hedge accounting requirements where uncertainty could arise in leading up to the transition. These amendments were mandatory and effective for annual periods beginning on or after 1 January 2020..
- Phase 2
Addressed potential financial reporting issues that may arise when LIBOR and other IBORs are replaced. These amendments are mandatory and effective for annual periods beginning on or after 1 January 2021. The amendments in this final phase relate to:
- changes to contractual cash flows. A company will not have to derecognise or adjust the carrying amount of financial instruments for changes required by the reform, but will instead update the effective interest rate to reflect the change to the alternative benchmark rate;
- hedge accounting. A company will not have to discontinue its hedge accounting solely because it makes changes required by the reform, if the hedge meets other hedge accounting criteria; and
- A company will be required to disclose information about new risks arising from the reform and how it manages the transition to alternative benchmark rates
Immediate priorities
The following actions can be taken as immediate priorities (among others) in assessing the impact of the reform and managing the related risks:
- Obtaining an inventory of all existing contracts that use LIBOR as a reference rate.
- Assessing whether the company will be able to apply the reliefs provided by the IASB in the Phase 2 amendments summarised above. Companies will be able to apply the reliefs provided by the IASB when contracts are modified as a direct result of the reform and if the new basis for determining the contractual cash flows is economically equivalent to the previous basis.
- All new contracts signed should not refer to LIBOR as a reference rate. Stakeholders involved in negotiations or contracting on behalf of the company must fully understand how the new reference rates will impact the economic substance of new contracts signed going forward. The table below includes a selection of the current reference rates and their respective replacement reference rates.
| Current | Replacement reference rate |
| USD LIBOR | SOFR (Secured Overnight Financing Rate) |
| GBP LIBOR | SONIA (Reformed Sterling Overnight Index Average) |
| EUR LIBOR | €STR (Euro Short Term Rate) |
| CHF LIBOR | SARON (Swiss Average Rate Overnight) |
| JPY LIBOR | TONAR (Tokyo Overnight Average Rate) |
| EONIA | €STR + Spread (8.5bp) |
- Assessing the implications of the transition on the financial covenants and any financial models.
- Assessing legal and tax implications of amending exiting contracts or signing of new contracts.
Closing thoughts
The reform will impact companies differently based on their dependency on the use of LIBOR. With only a few weeks left to the discontinuance of the use of LIBOR, is your business ready for this significant transition?
References
“Announcements on the End of Libor.” FCA, 5 Mar. 2021, https://www.fca.org.uk/news/press-releases/announcements-end-libor
“Ice Benchmark Administration Provides Update Regarding LIBOR® Cessation and “synthetic” LIBOR” Intercontinental Exchange – Home, Intercontinental Exchange – ICE Benchmark Administration Provides Update Regarding LIBOR® Cessation and “Synthetic” LIBOR (theice.com)
Rabecca Hichilo is an Associate Director with KPMG Zambia. The views expressed in this article are her own and not necessarily those of KPMG.
