Government funding schemes add to LIBOR headache
Governments across the world moved quickly at the start of the coronavirus crisis with a range of schemes to provide financial assistance to businesses affected by lockdowns and social distancing. Banks and other lenders are encouraged to extend loans to enable businesses to ride out the COVID-19 storm engulfing economies.
Indications are though, at least in the UK, the majority of loans approved so far use LIBOR, the interest rate benchmark discredited after the 2008 financial crisis when authorities found traders were manipulating it to make a profit.
While the UK’s Financial Conduct Authority (FCA) has extended its deadline for ending the use of Sterling LIBOR in new loans until the end of March 2021, lenders are only adding to eye-watering level of LIBOR exposed loan agreements currently on their books. New loans, as well as legacy debt using LIBOR, will need remediation before December 2021 when panel banks are able to stop issuing the rate.
The sudden need for funding and the limited implementation of SONIA, the risk-free rate for sterling markets issued by the Bank of England, mean lenders had little choice but to issue LIBOR referenced loans.
“At present, there is no appetite from the regulators to extend the deadline for the cessation of LIBOR, despite the pandemic,” said Guy Usher, partner and co-head of financial services and financial markets and products at European law firm Fieldfisher. “Given transition progress to date it is also unlikely that lenders, needing to move swiftly in responding to the call for emergency funding, will be issuing debt using anything other than conventional pricing right now and, for most lenders, that will mean using LIBOR as the interest rate reference.”
According to FCA figures, LIBOR is used as a benchmark rate in more than $30tn of financial contracts including derivatives, bonds and loans in Sterling markets. While the current government business interruption schemes are unlikely to contribute substantial volumes to this, (currently estimated at $330 bn), they will nevertheless compound the headache that already exists on lenders’ books.
“Loan market participants have the dual task of sorting out their tough legacy contracts and recalibrating their systems for new rate conventions,” said Philip Abbott, partner and co-head of financial services and financial markets and products at Fieldfisher. “Those lenders that are not fighting fires with bad debt provisions or who have mothballed new lending have the opportunity to accelerate the move across to risk-free rates like SONIA.
“This exercise was already causing a headache for lenders, but the added pressure of coronavirus could lead to a rather nasty migraine.”
