LONDON (BLOOMBERG) – Corporate treasurers in crisis-fighting mode look set to miss looming deadlines to abandon the scandal-plagued Libor benchmark, threatening a showdown with regulators powering ahead with reforms.
In the grip of this once-in-a-generation pandemic, many businesses have already “written off” this year when it comes to shifting away from the reference rate that has underpinned trillions of dollars in loans, bonds and derivatives, according to the Association of Corporate Treasurers.
Lenders and borrowers risk entering a legal no man’s land when Libor expires at the end of 2021 – relying on the generosity of regulators and counterparties for their contracts to be recognised. UK officials said last month that firms should stick to the final target, but acknowledged the virus outbreak has affected the transition plans of many businesses.
“Are regulators going to be flexible in their guidance and directives. This is the question I get,” said Michele Navazio, a partner at Seward & Kissel LLP in New York. “The answer I give clients is ‘who knows?'”
The US group that’s guiding the transition to the new Secured Overnight Financing Rate (SOFR) – the heir presumptive in dollar markets to Libor — revealed a framework last week for moving cash products from the old to the new benchmark.
But as the spreading coronavirus sparks an historic collapse in consumption and investment, the complex task of re-engineering a web of financial contracts is on the backburner among treasurers.
Lawyers and consultants are warning corporations from Europe to America that missing the final deadline could materially impact repayment costs and liquidity, while the market volatility only underscores the benchmark’s manifest flaws.
The risks associated with Libor-linked loans are rising. In the UK from October, banks still using securities tied to the rate will be effectively penalised through a limit on their borrowing from the Bank of England (BOE), tightening their balance sheets and making it harder to lend to companies fighting for their lives.
Corporate treasurers “may be in their pajamas but are working flat-out”, said Caroline Stockmann, chief executive of the Association of Corporate Treasurers, a global trade body. “It’s all about liquidity, all about survival and not about the reference rate in over a year’s time from now.”
Smaller British companies with Libor-linked loans in particular could lag in their financial planning even as bankers forge ahead with their transition plans, said Ed Moorby, risk advisory partner at Deloitte.
Similarly, hedge funds, asset managers and commercial borrowers and issuers of debt “were just coming to grips with the shift and now this happens”, said Seward & Kissel’s Navazio. “What are they doing now? The short answer is they are not worrying about Libor.”
The Financial Conduct Authority (FCA) and the BOE said last month that the UK loan market has made less progress, which may affect some of the milestones.
The two agencies and the Working Group on Sterling Risk-Free Reference Rates “will continue to monitor and assess the impact on transition deadlines, and will update the market as soon as possible”, they said at the time.
For now, banks have until the end of September to cease issuing cash products linked to sterling-denominated Libor. The FCA told asset managers to consider ceasing to launch new products with benchmarks or performance fees linked to the benchmark by then.
The demand to stop lending in Libor is the key concern, said Joshua Roberts, associate director at advisory firm Chatham Financial, who said the deadline was “always very aggressive”.
In the US, the Alternative Reference Rates Committee, effectively reminded firms last week that work on SOFR is still progressing. The committee will release a final recommendation of the spread adjustment methodology for cash products in the coming weeks.
As the clock ticks, companies are being advised to ensure they include fallback language in their contracts that allows the use of a replacement benchmark by the end of next year.
This won’t substitute for proper management of the transition but it could help keep companies away from messy lawsuits. Without the fallbacks, “a customer who has a Libor-linked loan from you could say the contract is frustrated and you end up in litigation,” Deloitte’s Mr Moorby warned.
Not everyone has abandoned their plans. Chatham Financial’s Mr Roberts said a number of funds are working intensively to find exposures and sort out legacy contracts. Many companies are hoping for an official delay, as happened with the MiFID II securities rulebook in Europe and the Dodd-Frank Act in the US.
Yet this could lead to a regulatory game of chicken, with officials wary of easing the pressure in case Libor never ends.
“What used to be good isn’t really working and what’s supposed to be replacing it isn’t really working,” said John Coleman, senior vice-president at RJ O’Brien & Associates in Chicago. “The fuse is burning.”
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