Even though the US Federal Reserve and United Kingdom regulators have been aggressively urging banks to prepare for the 2021 phase-out of LIBOR (London Interbank Offered Rate) as the primary benchmark for overnight borrowing costs for banks, current reporting estimates that at least 50% of companies questioned have not yet focused on replacing LIBOR, and only about 34% of financial institutions questioned state that they are on track for the approaching year-end transition.  

What is LIBOR? 

LIBOR, the rate that is calculated from an average of banks that participate in overnight lending to each other, is critical for short-term funding that financial institutions use for their operations. Unfortunately, LIBOR has seen controversy over the years, particularly being held accountable for the role it played in the 2008 financial crisis.

What you should know about LIBOR 

LIBOR has served as the reference rate for trillions of dollars in mortgages, business loans, derivatives, and other financial contracts worldwide for years. But since 2017 the Federal Reserve has been warning banks that they should stop writing contracts using LIBOR as a standard rate by the end of 2021.  After that date, the rate no longer will be published and as such, contracts using LIBOR should wrap up by June 30, 2023. 

What is SOFR? 

Despite the repeated warnings from regulators for the past five years, many companies continue to fail to proactively switch to new reference rates even though they have been warned that LIBOR will be phased out and eventually replaced by June 2023 by the Secured Overnight Financing Rate, or SOFR. 

The difference? 

Instead of relying on bank quotes, SOFR will use rates that investors offer for bank securities such as loans and assets backed by bonds. Most importantly, SOFR transactions will take place under the New York Federal Reserve’s auspices in its bond repurchase market. 

Business owners should be discussing these changes with their financial institutions and internal financial teams to ensure a smooth transition from LIBOR to SOFR (or another reference) for their existing and new loans. Planning will avoid complications with amending loan agreements down the road, but there are still several challenges ahead including a lack of standardization of how SOFR is averaged, volatility in rates, and finalizing accounting, tax, and regulatory relief to help in the transition. 

If you have any questions regarding LIBOR or its replacement, SOFR, please email Chris.Martin@SobelCoLLC.com and he will address your concerns confidentially.

About the Author

Chris Martin is a Member of the Firm in the Assurance Practice at SobelCo. He has worked closely with mid-sized, privately-held businesses throughout his entire career. Chris adds value by assisting clients with their financial statement needs, providing strategic planning for their corporate and individual income taxes, and actively consulting on major financial decisions. As the Member in Charge of the Food + Beverage Practice at SobelCo, Chris primarily consults with clients in the industry ...