How to Prepare for the Phase Out of LIBOR Despite Industry Uncertainty
By Axiom Law
The phasing out of the London Interbank Offered Rate, or LIBOR, in 2021 is one of the most wide-reaching developments the financial industry has seen in decades and, on top of current global uncertainty, poses a significant challenge. Even though UK regulators announced LIBOR’s phase out in 2017, the financial industry has found that even a years-long time frame is dauntingly brief. Since the 1970s LIBOR has been the benchmark estimated short-term interest rate at which banks may borrow from one another and its end impacts financial institutions around the world.
The regulators’ announcement came without a playbook for transitioning to new reference rates, how legacy contracts could be preserved, or new contracts created. These interest rates affect $400 trillion of agreements per year, in derivatives, loans, and other financial products – underlining the urgency and significance of devising a smooth transition to alternative reference rates (ARRs). Despite these high stakes, 20% of financial industry participants say they are not operationally ready for a world without LIBOR, and 53% of industry participants believe their businesses lack the internal talent or capabilities necessary to prepare by the end of 2021.
Axiom lawyers have already assisted over 20 companies prepare for the transition from LIBOR and share insights on what businesses must think about as they prepare and ready to provide additional, flexible legal support to companies that need it.
The Transition from LIBOR
Perhaps ironically, LIBOR’s sunsetting was welcomed by many financial industry stakeholders. The financial crisis of the late ‘00s curtailed the liquidity of the interbank lending market, also coinciding with an international scandal implicating some banks in attempting to manipulate LIBOR. To many in the industry, adopting a rate that reflected real market transactions is seen as a logical evolution.
However welcome the transition from LIBOR has been, the process of addressing countless LIBOR-reliant deals has created serious strain to financial firms’ in-house legal departments. Legacy deals pose a particular challenge for legal teams because they will still be in effect post-LIBOR, and so need to be amended and remediated. For a single international financial institution, this could mean analyzing tens of thousands of documents just to verify whether or not they need to be amended. The discussion about how to manage this process is broad and currently still unresolved.
In the US, alternative rates to LIBOR have been identified, with some calculations yet to be completed. However, as Axiom lawyer and LIBOR specialist Charles Green points out, “loans, derivative products, and swaps are still being written referencing LIBOR. The documents need more robust fallback language. We're still figuring out what the fallback language will be. So, we are still in the preparation phase for transitioning from LIBOR.”
Indeed, the language of financial documentation poses a mammoth challenge for businesses. Incorrect wording in a financial document could lead to a mismatch in rates, which could open the door to arbitrage and increased legal costs. The documentation review process today can be accelerated considerably via automation, such as artificial intelligence and machine learning, which lightens the load for in-house legal teams and reduces the labor outsourced to external legal professionals. But AI does not fully replace human legal expertise – it requires specialized knowledge and time to train the algorithm, perform quality assurance, and identify bespoke language in documents, as well as check the work of the AI tool. To transition away from LIBOR as smoothly and efficiently as possible, businesses in the financial sector need the expertise of legal talent who understand the documentation and the financial products that will be affected.
How to Prepare for LIBOR’s Phase Out
To prepare for the December 2021 transition away from LIBOR, while limiting potential disruptions to business operations and client services, Axiom lawyers Charles Green and Gail Pflederer suggest adopting the following practices:
- Record all aspects of your business that reference LIBOR.
- Through the course of normal business, note where LIBOR-related documents are stored.
- Develop fallback language and protocol for a post-LIBOR reality.
- For larger financial firms, this is a significant operational task, but proactive preparation strategies can help a business remain competitive.
- Communicate to clients what the transition away from LIBOR and toward ARRs means for them, and what your business is doing about it.
- Locate pertinent documents before sharing this communication with clients.
- Prepare communications in advance so you can share with clients as soon as your business has made decisions about documents’ language and amendments.
- Involve your business’s highest-level decision-makers in the transition process.
- Highlight and communicate the urgency to employees across the organization.
- Key decisions are made at ARR committee hearings, and senior-level representatives from all pertinent teams, such as legal, operations, sales, and tech, should be involved.
- Create a strategy for reviewing a body of documents that broadly affect your products, clients, and partnerships.
- Identify stakeholders in all financial products, including derivatives, swaps, lending agreements, credit agreements, and mortgages.
- Work with stakeholders to agree on replacement rates. Expect that different agreements will necessitate different decisions based on the language of the original documents.
- Develop a process for information to flow smoothly across operations, tech, and legal departments.
- Communicate with the trading desk – the last touch point before the client – to understand what data is most important to them, and how they will use it.
- Devise a framework to both store and locate the documents (operations), interpret the documents (legal), and algorithmically digest the data.
All of these practices should involve some combination of in-house legal teams that understands the financial firm’s particular business, specialized legal talent who understands the specifics of LIBOR, and technology that can speed along the document review process by identifying keywords and boilerplate. Lawyers who specialize in LIBOR are valuable in defining the categories that the provisions of the documents will be algorithmically sorted into, prior to amendment as necessary.
For in-house legal teams, addressing LIBOR is an additional task beyond their individual specializations and normal day-to-day work. In these periods of great urgency and considerable uncertainty, there is particular value in outsourcing these highly technical, specialized tasks.
“As an Axiom attorney, one of the ways we can make ourselves useful is to relieve in-house lawyers of the burden of this extra task,” says Green. The Fortune 100 financial services company where he is currently engaged and aiding in the transition “has a bird’s-eye view because they have exposure to what other firms are doing,” he says. “They told me that Axiom is ahead of other firms in terms of the progress made in addressing LIBOR.”
Axiom’s bench includes over 150 lawyers with LIBOR experience. They are positioned to assist financial firms in key LIBOR-related processes like conducting impact assessments, developing a roadmap for implementation, communicating clearly and getting buy-in from various teams and stakeholders, reviewing provisions and documentation, defining language for amendments, and QAing automated aspects of the transition process.
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