Upcoming discontinuation of LIBOR speeds decisions regarding transition rules

During the last 35 years, global financial markets adopted LIBOR (London Interbank Offered Rate) as the benchmark reference interest rate for international transactions denominated in the following currencies: British Pounds Sterling (GBP), U.S. Dollars (USD), Japanese Yen (JPY), Euro (EUR) and Swiss Francs (CHF).

LIBOR is a term-rate calculated based on quoted rates provided by global banks regarding the interest rates they would charge for different short-term interbank loan maturities. LIBOR was discontinued on December 31, 2021, except for the reference rate for USD transactions having a 1-month, 6-month and 12-month maturity, all of which will be discontinued on June 30, 2023.

The discontinuation of LIBOR is a result of several factors, including that its methodology was deemed to have become obsolete and subject to distortions given the current complexity of global financial transactions.

LIBOR has been replaced by risk-free interest rates, which are based on the average volume of overnight interbank transactions, such as: (i) the Sterling Overnight Index Average (SONIA) for transactions denominated in GBP; (ii) the Secured Overnight Financing Rate (SOFR) and the Bloomberg Short-Term Bank Yield Index rate (BSBY) for transactions denominated in USD; (iii) the Tokyo Overnight Average Rate (TONAR) for transactions denominated in JPY; (iv) the Euro Short-Term Rate (€STR) for transactions denominated in EUR; and (v) the Swiss Average Rate Overnight (SARON) for transactions denominated in CHF.

Many agreements indexed to LIBOR do not contain adequate provisions to address the discontinuation of LIBOR. As a result, parties to financial transactions indexed to LIBOR have been working to negotiate contractual amendments providing for the replacement of LIBOR by an alternative among the risk-free interest rates. Typically, such contractual amendments contain fallback provisions applicable if the selected replacement index is itself discontinued or becomes otherwise unavailable.

This process should intensify as we get closer to the definitive discontinuation of LIBOR by the end of the first semester of 2023.

Finally, we note that, pursuant to New York Law, in the event that parties cannot agree on a transition rule for financial agreements indexed to LIBOR, SOFR would be applied upon the discontinuation of LIBOR.

Authored by Isabel Costa Carvalho, David Tyler, and Felipe Lacerda.