In less than a month, on 1 January 2022, the London Interbank Offered Rate (LIBOR) will be replaced by risk-free reference rates (RFRs). Nearly five years after the official announcement — and in the face of more recent geopolitical, economic and public-health upheavals — lenders, borrowers and investors may have forgotten the approach of this important event. But now that the end of LIBOR is nigh, what should you know?

LIBOR is the benchmark interest rate at which major global banks lend to one another in the interbank market. LIBOR represents the average rate at which certain leading banks can borrow money from one another. It is also a key benchmark interest rate for a range of financial products, including adjustable-rate loans and certain mortgages.

Beginning with the new year, the UK’s Financial Conduct Authority (FCA) will no longer require banks to provide quotes for LIBOR, with the result that LIBOR will cease to be published and become redundant. 

LIBOR is being replaced for two key reasons: the lack of volume of interbank lending transactions, which has resulted in an unreliable benchmark; and the widespread manipulation of LIBOR following the global finance crisis, which led regulators to question LIBOR’s future.

LIBOR will be replaced with RFRs, which represent a theoretical rate of return on an investment with zero risk of financial loss. In sterling markets, the preferred RFR is the Sterling Overnight Index Average (SONIA), which is based on actual transactions and also reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions and other institutional investors. Whereas LIBOR is (or, in a few weeks’ time, “was”) a forward-looking rate, SONIA is a backward-looking rate: the interest payable will only be known at the end of the period.

Use of SONIA is not mandatory, and parties may use a base-rate amount or other benchmark. As a practical matter, SONIA is already causing some concern for lenders and borrowers, in part because of its complexity and in part because of its backward-looking approach. Simply put, borrowers want to know in advance their cost of borrowing, information that SONIA precludes. 

Despite the efforts of many organisations to ensure that their contracts are ready for the move away from LIBOR, some contracts reliant upon LIBOR (known as legacy contracts) will continue after the transition. To address this situation, the FCA announced that it would allow legacy use of synthetic rates “at least for the duration of 2022” and that it would publish a synthetic sterling LIBOR rate after 31 December 2021 for contracts that have not been revised to accommodate the discontinuation of LIBOR. Thenceforth, references to LIBOR in legacy contracts will be read as references to “synthetic LIBOR.” That noted, the FCA also has been consistent in its opinion that synthetic LIBOR should now be the rate of last resort.

One LIBOR is gone, even contracts that include fallback provisions in expectation of a time in which LIBOR ceases to exist may not work in practice, thus leading to disputes. Such disputes may include, for example, allegations of “mis-selling,” or claims where a financial institution is accused of having led retail customers into agreeing to contracts that still reference LIBOR despite the institution knowing it was soon to come to an end, or where a party argues that one duped the other into agreeing to a contract that has untold financial consequences.

Given these uncertainties, parties with legacy contracts should take action to address these issues and avoid potentially complex and costly disputes.

For more detail on the LIBOR transition and its impact on legacy contracts referencing LIBOR, click here for the full blogpost by James Walton of Ally Law member firm Edwin Coe LLP.