Some mortgage, business loans may need updating with looming LIBOR bank rate phaseout.
Q: What is LIBOR?
A: The London Interbank Offered Rate (LIBOR) is the daily calculation of an average of estimated interest rates that a panel of around 20 banks calculate they’d be charged to borrow from other banks. LIBOR serves as the primary reference interest rate that’s overwhelmingly used by lenders to set their own interest rates including mortgage and student loan lenders, as well as credit card companies. It’s been used since 1986 for this purpose. LIBOR hasn’t been without its scandals, and in 2012, media outlets began to allege that LIBOR was being manipulated by the very banks that set the rate, leading to fines levied against financial institutions and prison sentences for individuals involved in the rate manipulation as well as regulatory backlash. The Financial Conduct Authority is the regulatory agency for LIBOR, and on July 27, in an apparent effort to replace rather than reform LIBOR, Chief Executive Andrew Bailey announced the recommendation that LIBOR phaseout at the end of 2021 due to a lack of confidence in the calculation as well as unwillingness among banks to use it.
Q: What’s the future of LIBOR and how could it affect consumers?
A: LIBOR has been used pervasively as a benchmark rate for loans for over 30 years. Most consumers have at least one agreement in effect that references LIBOR, whether it be a mortgage or business loan. Many of these contracts are long-term and won’t expire before 2021 when LIBOR will be phased out. Some of these loan contracts based upon LIBOR contain a fallback provision and reference an equivalent or alternative interest rate to be used in place of LIBOR, laying the foundation for those instruments to be governed by LIBOR’s eventual successor. However, lenders and borrowers should review existing loan documents, especially those continuing after 2021, to ascertain whether they’re LIBOR-based loans and then whether they reference an alternative rate in the event that LIBOR is no longer published. Those documents without fallback provisions or an alternative rate should be amended and updated so that they reference a substitute or new rate to avoid legal uncertainty once LIBOR is replaced.
Q: What will replace LIBOR?
A: LIBOR’s administrator will continue to produce LIBOR until 2021 and possibly after that time if banks continue to contribute to the benchmark rate, so there’s still time to figure out what will replace LIBOR, but there’s currently no go-to replacement. Lenders and borrowers should consider use of fallback provisions and flexible amendment provisions due to the unavailability of LIBOR in the future.