An announcement by the administrator of the London Interbank Offered Rate (LIBOR) that it will delay to mid-2023 the sunsetting of some of the most commonly used tenors of the benchmark rate "widely reduced credit risk because it provides additional time for U.S. dollar exposures to decline and for issuers, structured finance deals and others to prepare" for a switch to alternative reference rates, Moody’s Investors Service said in a report.
The U.K. Financial Conduct Authority on March 5 said the final fixings for most LIBOR rates — including 1-week and 2-month U.S. dollar LIBOR — will be made on Dec. 31, 2021, but other U.S. dollar tenors may continue until June 30, 2023.
- The announcement set "a clear path for the change to alternative reference rates," Federal Reserve Vice Chair Randal Quarles said in a statement, adding "in the months ahead supervisors will focus on ensuring that firms are managing the remaining transition risks."
For over three years, regulators in the U.S., U.K. and other countries have called on companies to switch to alternative reference rates from LIBOR, the benchmark for trillions of dollars in business loans, derivatives and other financial contracts worldwide.
Companies face big challenges in phasing out the reference rate. LIBOR is woven into core operations, including valuation, accounting, tax and debt management. Some debt instruments are held by hundreds of investors who will need to agree on any modifications.
A flawed LIBOR transition could jeopardize market stability, the Financial Stability Oversight Council of U.S. regulators said in its annual report.
"The failure of market participants to adequately analyze their exposure to LIBOR and transition ahead of LIBOR’s anticipated cessation or degradation could expose market participants to significant legal, operational and economic risks that could adversely impact U.S. financial markets," the council said.
Regulators have urged companies not to use LIBOR in new contracts. "Market participants need to swiftly move to robust reference rates," New York Federal Reserve President John Williams said in a statement.
Adoption of the alternative reference rate favored by U.S. regulators — the Secured Overnight Financing Rate (SOFR) — has accelerated during the past several months but, because of some disadvantages, is far from eclipsing LIBOR.
SOFR is based on overnight repurchase agreements secured by Treasuries and, unlike LIBOR, does not enable treasurers to make forward-looking rate calculations. LIBOR is based on London banks' estimates of what they would be charged when borrowing from other banks.
"The delay in the U.S. dollar LIBOR transition, which came after the COVID-19 pandemic somewhat slowed transition preparation, will allow a greater share of outstanding LIBOR instruments to mature or otherwise pay off," Moody’s said.
"The delay will also provide extra time for issuers and transactions with more challenging longer exposures to address the risks, or benefit from developments such as legislative action," Moody’s said.
Phasing out LIBOR may prove especially challenging with U.S. collateralized loan obligations, student loan asset-backed securities and financial contracts with weak fallback language maturing after 2021.
"Any organization delaying their efforts to move away from LIBOR is doing so at their own peril," PwC said in a report. The FCA announcement on LIBOR’s end "will only increase the pressure and expectations for firms to accelerate the shift to alternative reference rates."