Preparing for a shake-up in global finance

Large companies are probably ready for the obvious effects of the impending shift away from LIBOR, but hazards could be lurking in unexpected places.

LIBOR buzzes in the C-suite like cicadas in a picnic meadow — not always seen, but always humming in the background. Even if you don’t know exactly what LIBOR is, you probably know that it underpins much of the financial sector and sets payment terms for a whole host of your company’s transactions.

But that background hum is about to fade. LIBOR — or the London Interbank Offered Rate — is a widely used interest rate index based on two things: submissions from panel banks, which are very active in the euro market and estimate what they would be charged if they were to borrow from other banks, and observed transactions. But in 2017, the British regulators who oversee the rate calculations concluded that there simply aren't enough actual transactions, particularly for longer terms, to support the estimates bankers are making. So, after 2021, those regulators will no longer require banks to report these estimates, and as a result, most analysts predict LIBOR will eventually vanish. Financial transactions already on the books and those not yet finalized will have to reference a replacement rate. And although markets have had more than two years so far to prepare, many corporate executives still aren’t ready for the change.

Treasurers at most large companies have probably taken stock of the most obvious potential hazards in the LIBOR transition. For instance, managing corporate debt and managing liquidity will become difficult if LIBOR-based assets become harder to sell as 2022 approaches. But in many cases, banks are helping their corporate clients address these issues.

No bank will help your corporation scour its far-flung departments for LIBOR-dependent contracts, or update the financial systems and processes that have built up around them. You’ll have to do it yourself.

The more insidious problem is that LIBOR is ingrained in countless small ways across a large company’s entire business. It’s referenced in leases; in accounts receivable, where, for example, late payments could trigger a penalty based on LIBOR; and even in financing products offered to customers. It’s sometimes found in purchasing contracts, embedded as a component of the purchase price. And it figures into transfer pricing agreements between global affiliates.

These indirect exposures, taken together, are often even larger than direct exposures in debt and liquidity management. If these LIBOR references aren’t addressed, your company could end up in a fight with your counterparties about how contracts should be paid. Or, if your contracts simply cite the last available published rate, then previously variable-rate contracts would effectively turn into fixed-rate contracts if or when LIBOR is no longer published. No bank will help your corporation scour its far-flung departments for LIBOR-dependent contracts, or update the financial systems and processes that have built up around them. You’ll have to do it yourself, and here’s how.

Lead from the top. Fundamentally, the task force you establish to manage your company’s transition from LIBOR to other reference rates must take the broadest view possible. Because the corporate treasury manages debt and liquidity, it’s natural to tap it to lead a transition task force. But the mandate for change must come from above, from the chief financial officer (CFO) or someone in an even higher position. Taking inventory of your LIBOR exposure will require you to devote resources to the effort for at least several months, turning over rocks that are spread out across your entire enterprise, and a treasurer simply doesn’t have the pull to force cooperation from indifferent or busy peers. We’ve had a client in this situation who, lacking leverage to mobilize his colleagues, pleaded with us to send him materials from the media about the transition so he could persuade the C-suite to give him the authority to act. Without an executive sponsor to make the LIBOR transition a company priority, the task force’s chances of success are low.

Identify your indirect exposure. This is the hardest part of the process. In an ideal world, at least for a company that’s heavily centralized, your LIBOR task force would spend much of its time in the general counsel’s office, because theoretically, those lawyers review and track all of the firm’s contracts. In practice, though, most companies are not nearly that well organized. Your task force, then, should include, in addition to the legal department, leaders from every corporate function that could possibly write or sign a contract that might reference LIBOR. Naturally, those functions will vary by the company, but at a minimum would include accounts payable and receivable, procurement, supply chain financing, and, for firms that use transfer pricing, the tax department, which typically sets those rates. The actual work of searching contracts for references to LIBOR can be facilitated by software if it’s thoughtfully set up and incorporated into the review process.

Prioritize the risks. Once you’ve identified all of your potential exposures, the next step is to prioritize your risks based on things like the size of the exposure, the likelihood that a LIBOR-based provision (e.g., a payment penalty) will ever be invoked, and the difficulty of adjusting the provision. For example, short-term contracts that routinely expire and must be re-signed present a natural opportunity to replace the reference rate without disruption, so it’s best to be prepared when they come up for renewal. Often, the LIBOR benchmark is essential to a contract, a fundamental element of the interest payment or purchase price. On the other hand, late-payment provisions that rely on LIBOR might seldom get triggered and so might land further down your priority list.

Remediate. For pure financial contracts, central bank working groups and broker–dealer trade associations have established timelines for the transition away from LIBOR, such as the ARRC's paced transition plan, and recommended fallback language that banks can use in new and amended contracts. For example, the International Swap Dealers Association (ISDA) is developing a protocol that stipulates what happens with derivatives contracts when LIBOR ceases to be published. For corporate debt, banks and other lenders will likely spearhead changes.

But for contracts that aren’t chiefly financial, enterprises will likely need to drive the transition efforts rather than rely on a bank or other institution to tell them what to do.

Educate and communicate. A key element of negotiating these changes will be education. To mobilize effectively, you should start by explaining to stakeholders across your enterprise what LIBOR is and what the implications of the transition away from LIBOR are, and then give them some examples of LIBOR-related provisions. Then, you’ll have to prepare your counterparties, customers, and investors. The people who negotiate B2B contracts aren’t always, or even usually, financial experts; they plug in LIBOR because LIBOR is what’s always been used. A careful explanation of what you’re trying to undertake will go a long way in reassuring your counterparties that your goal in amending terms is to get things right, not to take advantage.

And finally, investors and regulators will also be expecting you to thoughtfully navigate the LIBOR transition. Be transparent with them about your transition plan and communicate with investors about how LIBOR impacts them and what your company is doing about it.

The move away from LIBOR is one of the biggest changes that’s ever happened in the world of global finance, but if you follow this plan, you should be able to take the transition in stride.

Jonathan Bergeson

Jonathan Bergeson is a leading practitioner for treasury services in the US financial markets practice.  Based in the San Francisco Bay area, he is a partner with PwC US.

 
Marguerite Duprieu

Marguerite Duprieu is a member of PwC’s global LIBOR working group. Based in New York City, she is a director with PwC US in the financial markets practice.

 
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