LIBOR stands for London Interbank Offered Rate and is the average interest rate at which major global banks lend to one another. For the past few decades, it has been the benchmark interest rate for consumer loans worldwide, such as credit cards, car loans, adjustable-rate mortgages, and business loans as well as investment instruments such as swaps, bonds and other items. While not all interest rates are based on the LIBOR it is common enough that you should be aware of it and know that it is coming to an end soon. The exact date has not been set but it is expected to be discontinued sometime in 2021.
There are multiple factors that have led to the decision to stop using LIBOR. One reason is global markets have grown and become more complex since LIBOR was introduced but the calculation has not been changed much causing it to become outdated. Another is that in 2012 it was discovered that banks were manipulating the LIBOR by reporting false interest rates to their benefit. Also, the LIBOR was based on the cost of an activity that the banks do not really do anymore. As a result, it has been decided LIBOR will eventually come to an end.
With the end of LIBOR another rate will take its place, but that rate will depend on the region and currency. Not all regions and currencies will use the same rate to replace LIBOR. Currently, it is expected that the U.S. Dollar LIBOR will be replaced with a new rate, the Secured Overnight Financing Rate (SOFR). If you conduct large amounts of business in foreign currencies and markets you should investigate the new rate for those currencies.
I am sure your wondering what this means for you. The first thing to figure out is if you currently have any loans, investments, or other financial instruments with rates based on LIBOR. If you do, you will need to review the contracts to see if they include “fall back” terms regarding what will happen if the LIBOR is not available. It is important to understand these terms because it could result in significantly different interest rates on your contract. If you have a large loan it could cause a significant increase in interest expense. Another effect could be decreased return on investments due to a lower interest rate. Whether or not there are “fall back” terms it would be prudent to reach out to the other parties of the contracts, as well as legal counsel, to ensure you understand how this change will affect you and your current contracts.
Going forward, you will want to make sure any new contracts have “fall back” terms if they are based on the LIBOR. Most financial institutions have been aware of its coming end and are building specific terms into their contracts for the transition to SOFR. Regarding the overall financial markets, there are so many unknowns it is hard to predict the effect the end of LIBOR will have on them. Even if you do not currently have any financial instruments that use LIBOR it is important to be aware of the upcoming change as you make future borrowing and investing decisions.
Contact your Henry+Horne audit professional with any questions.
Davis Smith, CPA