From 2022, there will be a transitioning from the use of London Interbank Offered Rate (“LIBOR”) as the predominant benchmark interest rate to other alternative rates for five currencies. There is significant uncertainty about how the transition to these risk free rates will be implemented. Involvement of legal, finance and tax, treasury and business operations are likely in a LIBOR transition project due to its broad-reaching impacts.
From 2022, there will be a transitioning from the use of London Interbank Offered Rate (“LIBOR”) as the predominant benchmark interest rate to other alternative rates for five currencies. LIBOR for US Dollar, Pound Sterling, Euro, Japanese Yen and Swiss Franc will be replaced by risk free rates (RFRs).
There is significant uncertainty about how the transition to RFRs will be implemented. There will be no single global successor to LIBOR. Instead it is currently expected that for:
Some of these new rates are already available in the market, however the timing and precise nature of the change is uncertain.
Although the Australian (BBSW) and New Zealand (BKBM) benchmarks are not currently affected, there is an increasing awareness of alternative rate for Australia. For example, the Australian Overnight Indexed Average (AONIA) was used as the benchmark rate in a recent bond issue.
Entities with exposures to LIBOR are encouraged to start planning and preparing how they may be impacted by the phasing out of LIBOR and transitioning to new benchmark rates to ensure the change has minimal financial and operational impact.
“Transitioning to a world beyond LIBOR represents a significant challenge to organisations, and the impact is not limited to financial institutions. In order to ensure a smooth transition, entities should engage early and ensure they are identifying all impacted contracts to allow time for contractual renegotiations”.
– Patricia Stebbens
Involvement of legal, finance and tax, treasury and business operations are likely in a LIBOR transition project. A project will include the following considerations:
Whilst it may be relatively straight forward for some entities to identify funding arrangements, including financing from financial institutions such as banks, or the debt capital markets, or intercompany funding and derivatives that are referenced to LIBOR, entities should also consider other contracts that may be impacted such as lease contracts or procurement or sales contracts. For example, some supply contracts in the extractive industry or energy market contain penalties linked to LIBOR.
Management may need to implement a process to ensure that all exposures to LIBOR are identified and managed. Contracts need to be analysed to determine the appropriate strategy for achieving contractual changes (in advance of the changes being applied, rather than maturity of the existing contractual arrangements).
Entities should also ensure any new contracts entered into that are expected to extend beyond 2021 have provisions in the contract that will enable them to have a seamless transition to the new benchmark rates.
For all exposures identified, entities will need to commence negotiations with the counterparty to determine the new appropriate interest rate to be used in place of LIBOR. This may involve significant costs and added complexities as different jurisdictions are moving to different RFRs.
The software in many treasury systems relies on LIBOR information for valuations and other processes. These entities will need to establish the appropriate strategy for uploading the changes onto the treasury systems in a timely manner.
These treasury valuation systems changes cannot wait until 2021. If entities have existing instruments that extend beyond 2021, systems will need to be reviewed to ensure that they could be updated with new discount rates in order to appropriately value the financial instruments (and potentially any amended cash flows on them).
This may be a challenging process as insufficient liquidity in RFRs may cause challenges in the constructions of the interest rate curves.
Changing interest rates are likely to have significant accounting consequences including:
Entities should consider whether there are any potential taxation impacts, such as transfer pricing due to the potential repricing of any intra-group loans.
Entities should also consider other broader business consequences of LIBOR replacement such as value transfers between different stakeholders. For example, in the fund industry where values are attributed based on fair value as the inputs to the valuation methodology change as a result of the phasing out of LIBOR.
KPMG can assist you in a number of areas, including:
Refer to the PDF version of the Reporting Update for more detail of the above and relevant KPMG experts to contact.
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