Libor Rate Changes and the Future of Your Business
January 12, 2022
An explanation of plans to phase out of the LIBOR rate, and the important discussions and actions you need to take now to prepare your business.
In simple terms, LIBOR is set using the average rates that global banks estimate they would pay if they borrowed money from other global banks. Since these rates are estimates and not the actual rates used by banks, it could be possible to manipulate LIBOR. Due to the growing number of scandals surrounding LIBOR and the fact that LIBOR rates have become a less reliable benchmark, After December 31, 2021 some LIBOR rates will no longer be published and a compete phase-out of LIBOR rates is expected by June 30, 2023.
Once LIBOR is gone, it will be replaced by SOFR “Secured Overnight Funding Rate”, which is set based on the actual rates that banks pay on overnight loans, making this a more reliable benchmark and not easily manipulated.
How will this affect your business?
As of result of these changes, companies should examine what impacts this transition will have on their business and on their financial statements. Some questions companies need to ask themselves are:
What existing debt does the company have and does it reference LIBOR as the rate?
If my rate is based on LIBOR, is the maturity date of the loan after December 31, 2021?
Is there language in the debt agreement regarding the calculation of reference rate differences?
Could this possibly impact debt covenant calculations? Changes resulting in higher interest rates result in higher interest expense, which may indirectly impact some debt covenants.
Could financing contracts impacted by the change in rates be renegotiated?
Will any of the contract modifications be accounted as a continuation of an existing contract or extinguishment of debt?
Hedging transactions, such as interest rate swap arrangements, referencing a LIBOR rate could result in the hedge becoming ineffective, which could then change the accounting treatment of the transaction.
For financial statement reporting, the FASB (Financial Accounting Standards Board) has issued guidance on rate reform in order to simplify the transition. ASU 2020-04 Reference Rate Reform Topic 848 allows companies to use an optional election to simplify accounting related to the LIBOR transition. The optional election applies only to contracts that reference LIBOR (or any other rate expected to be discontinued) entered into before December 31, 2022 and is effective for all entities as of March 12, 2020 through December 31, 2022.
It is important for you to start a conversation about LIBOR with your bank now so that you are not caught off guard when LIBOR ceases to exist.