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Time is almost up for the London Interbank Offered Rate (LIBOR), the soon-to-be-phased-out global interest benchmark that affects trillions of dollars in borrowing and other financial transactions. Yet many companies do not seem prepared for the transition, and the delay could result in significant business disruptions and increased borrowing costs. To better understand where the transition is getting bogged down, PwC surveyed 121 executives across a range of industries about their plans to move from LIBOR to alternative reference rates. We found that companies:
Want stronger guidance from their banks
Often don’t understand their replacement rate options
Are not prioritizing transition in the short-term
In one of the more surprising findings, 69% of respondents with USD LIBOR exposure told us they are not planning to transition their instruments until 2022 at the earliest, if they even have a date in mind. While some USD LIBOR rates will continue to be published for certain tenors through June 2023, this delay could expose companies to volatility and operational risk. The deadlines are even tighter for non-USD LIBOR exposure, as non-USD LIBOR disappears on December 31, 2021. This disconnect could cause problems for both borrowers and lenders.
Companies want stronger guidance from their banks
Nearly all respondents (97%) in our survey want banks to either take the lead in driving the transition to alternative reference rates or work alongside companies to plan for the transition. But many companies say they’re not getting the help they need.
In fact, 59% of those who haven’t started transitioning say a lack of guidance from their bankers is a major impediment to their transition. This may vary by product. Of companies that have derivatives with LIBOR exposure, 72% have either adopted the ISDA protocol or plan to. Still, many respondents seem somewhat unsure about exactly what steps to take.
Actions companies can take:
Inventory your LIBOR exposure to understand where you need help. In addition to LIBOR debt and derivatives, pay special attention to areas that aren’t clearly related to debt or derivatives, such as intercompany loans, executory contracts, transfer pricing arrangements and leases as these may also be linked to LIBOR. It can be time-consuming to identify all of your affected contracts and processes and to mitigate exposure, so you’ll want to begin this process early.
Reach out now to your external counterparties and advisors for transition guidance, education and to begin contract renegotiations.
Companies often don’t understand their replacement rate options
Many in the financial industry have assumed that USD LIBOR will be primarily replaced by the Secured Overnight Financing Rate (SOFR). The Alternative Reference Rates Committee (ARRC), a group of private-market participants convened by the Federal Reserve Board and the New York Fed, selected SOFR as its preferred replacement index. SOFR reflects the overnight rate charged in actual transactions in the US Treasury repo market and is considered a credit risk-free rate. But moving from a credit-sensitive rate (CSR) like LIBOR to a so-called risk-free alternative rate like SOFR is not a mere rip-and-replace.
For one thing, some market participants may find SOFR difficult to use depending on their systems and how SOFR is applied. There are a number of market conventions for applying SOFR, an overnight rate, in financial instruments that typically pay interest less frequently than daily. These include compounding in arrears, compounding in advance or simple average. To make matters more complicated, a variety of non-SOFR alternative reference rate (ARR) options have started to emerge to replace USD LIBOR. Faced with this, 35% of the companies we surveyed are unsure what borrowing rate they’ll use. Many may be waiting to see if a consensus develops around something other than, or in addition to, SOFR. Meanwhile, many banks have yet to fully adopt an ARR and lend on it. And, while certain lenders are looking to use newly developed CSRs as LIBOR alternatives, only 3% of borrowers say they prefer to transition to such a rate. While CSRs are gaining more traction within the USD LIBOR market, they could be subject to the same factors that undermined LIBOR, including a shortage of transactions to set the fixing in the event of a liquidity crisis, or that the rates will dynamically move as bank funding costs increase. We heard similar hesitations about using CSRs in borrowings during a PwC webcast with corporate clients earlier this year.
System upgrades ahead? Roughly a third of respondents plan to use a replacement rate that is compounded in arrears (11%) or computed using a weighted average that reflects daily exposure (20%). Calculating interest on a compounded in arrears basis reflects a shift from current industry practice and may require significant system updates. Unlike current LIBOR-based transactions in which rates are set at the start of the interest period and paid 30 or 90 days later, SOFR in arrears is fixed at the end of the interest period, compounded or averaged in arrears based on daily rates. Instead of plugging in a rate at the start of a loan term, companies might need to upgrade their system infrastructure to use this calculation method — and they would also need to address concerns surrounding cash management and operational issues caused by not knowing the exact amount of a payment until a few days before the end of a borrowing period.
Path of least resistance? Finally, a significant share of companies prefer a rate that is compounded in advance (9%) or a term rate that would be known in advance of a payment period (16%). These options would be relatively straightforward to adopt — but companies might pay more if their banks assume any tenor basis risk. For now, although the ARRC still hasn’t formally endorsed a forward-looking SOFR term rate, it has announced that the CME will be the administrator, and the CME is already publishing a term SOFR rate. Among companies that prefer term ARRs, 63% expect their transition to occur in 2022 at the earliest.
What type of alternative reference rate do you plan to use for new borrowing once LIBOR is no longer available?
Source: PwC Corporate LIBOR Transition Survey, April 29 - May 24, 2021: base of 121
Actions companies can take:
As you consider your exposure to products that are based on LIBOR, have a discussion with your bankers and other professional advisors about the attributes of your post-LIBOR alternatives. ARRs may be derived from different kinds of data sources and may vary in how they respond to different market environments. You’ll want to understand what risks are embedded in the pricing today and how those might change in the future. Each rate has its own inherent funding and operational risks, and there are trade-offs between transparency and volatility. Some benchmarks are likely to have more challenging system implementations than others.
Even as you let banks know about your ARR preferences, you’ll want to stay abreast of how the market is developing and understand how it could affect your organization. If market standards evolve in a way that you haven’t foreseen, you’ll want to have a backup plan in place that you can readily act on.
Many companies are not prioritizing transition
Financial institutions and corporate treasurers have known about the coming shift for years. For many companies, the LIBOR transition poses a range of known challenges from updating contracts and interest rate management to accounting, tax and investment strategy. To address these challenges, firms must know their exposure to know their risks associated with LIBOR cessation and plan accordingly. But even now, 5% of those we surveyed remain either unsure of or still figuring out their LIBOR exposure — and many more companies that do know their exposure are holding back.
More than two thirds (69%) of survey respondents with USD LIBOR exposure aren’t planning to transition their instruments until 2022 at the earliest, if they even have a date in mind. That’s partly because the December 31 deadline was recently extended for some rates. Even so, if your company is considering new facilities with regulated counterparties, any LIBOR options may be gone sooner than you might think. Regulators have made it clear that lenders should stop linking new loans and other financial instruments to USD LIBOR by the end of the year. That means that if your company expects to be in the market for floating rate debt in 2022, it should be prepared to consume new ARRs with new computational conventions discussed here. You should also be aware that the costs of hedging existing LIBOR exposures in the coming years will likely increase.
Companies with global operations may have already discovered this. For new GBP transactions, LIBOR indexing is no longer an option, and non-USD LIBOR rates affecting existing instruments will stop being published at the end of 2021. Cross-border issues like transfer pricing and taxation, and inconsistent timing in the phaseout of LIBOR rates makes these transitions even more complex. In spite of this, our survey shows that 58% of those with non-USD LIBOR exposure are either unsure of their timeline or don’t plan to address the issue until the fourth quarter.
Actions companies can take:
- Whether you use an in-house platform or an outside vendor for tracking LIBOR exposure, you’ll want to assess your ability to manage the transition and the upgrades that will be necessary to handle alternative reference rates.
Share your plan. The transition is not just a finance event. You’ll want to understand how this affects stakeholders across your company, including sales, legal, tax and other teams.
If LIBOR transition has slipped on your organization’s priority list, you’ll want to ensure that you completely understand the exposure across your entire company. Given the complexities involved, you should have developed a transition roadmap that allows sufficient time to transition all material exposures while minimizing the operational and economic disruption. Companies that wait could experience operational and system challenges as well as economic impacts.
Don’t wait any longer. Procrastinators will likely find it harder to get technical resources and sustained attention from vendors and counterparties, and this could limit your options. Meanwhile, financial resources are already drying up. There will be no new LIBOR transactions in any currency after December 2021.
The LIBOR transition survey
The takeaways for companies
Until now, many — perhaps even most — companies have moved slowly in response to the LIBOR phaseout. The topic has had its share of uncertainties, but we’ve now reached an inflection point. By waiting further, a company is probably not keeping its options open. Instead, it may be limiting its choices and adding to its operational and economic headaches.
Once organizations get engaged in the transition, they often recognize that replacing LIBOR with an overnight rate is far more complicated than they expected. Most businesses could face a range of challenges as they prepare to move beyond LIBOR, from identifying LIBOR references in contracts and operational changes to the way they manage things like liquidity, debt, investments, accounting and tax.
By the end of 2021, companies will not be able to get new LIBOR lendings. Regulators are stepping up pressure on banks to expand SOFR-based lending. As markets tied to ARRs add volume from new lending, LIBOR liquidity will likely drop, and this could drive up hedging costs for existing exposures. And because the work to support the transition can be substantial, the industry may start to encounter resource limitations as banks, system vendors and companies scramble to remediate their programs before the transition deadlines.
Our survey shows that many companies need help with their LIBOR transitions, that they often don’t understand how to evaluate their replacement rate options, and so they are continuing to delay. The good news is that the anticipated problems are avoidable — and by reaching out now for the help and coaching they need, companies are likely to get the attention they need and deserve.
The takeaways for lenders
Financial institutions can play a critical role in helping companies prioritize and steer this transition — and our survey indicates that this help is needed and wanted.
Companies need guidance on the evolution of ARR development in the marketplace, the bank’s own transition plans, and how they can adapt their processes and systems to accommodate SOFR and other ARRs that might emerge. It’s time to ramp up your client outreach efforts around LIBOR — not just as a negotiating counterparty but also as an educator to get them up to speed. Securitized transactions, which may have multiple counterparties, introduce additional complexity for clients. Lenders that help clients through this may strengthen their relationships and reinforce their brand messaging.
Companies told us they’re interested in a variety of different replacement rate options — though they have generally been less interested in CSRs than their lenders. Financial firms should assume that there may be multiple ARRs and compounding conventions in use. You’ll want to be sure your systems have the flexibility to adopt and service whatever ARRs and conventions for use ultimately prevail. You’ll also want to think about issues with compliance and conduct risk to be sure your clients understand the risks that might be inherent in the rates they agree to.
Finally, many companies aren’t prioritizing transition, but they will. For now, you’ll want to increase efforts to reach out and educate clients, including steps to heighten awareness of LIBOR transition's importance and complexities. While you are developing communications and training, analyzing your exposure and communicating with regulators, some of your counterparties are just starting to focus.
About the survey
121 financial officers from leading global companies weighed in on their approach to the LIBOR transition and alternative reference rates in PwC’s Corporate LIBOR Transition Survey, fielded April 29 to May 24, 2021.
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Jonathan Bergeson
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Marguerite Duprieu
Director, United States, PwC US
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Financial Services, Principal, PwC US
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Director, Treasury Advisory and Assurance, PwC United Kingdom
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