Changes in the Administration of LIBOR May Require Modification of Many Loan Agreements
by Edmund F. Richardson
The London interbank offered rate or LIBOR serves as the benchmark for many variable-rate loans. The system for establishing and managing LIBOR has traditionally been administered by the British Bankers’ Association. As explained below, administration of the system changed as of the beginning of February.
Many commercial loans, residential real estate loans as well as some credit card rates utilize LIBOR as the index upon which changes in interest rates are based. LIBOR has always been based upon rates estimated by banks in the London England market as a rate that would be offered and accepted on short-term loans between banks.
Many interest rate swap transactions, which are used by borrowers as a hedge against fluctuations in variable rates, have been based on LIBOR. Typically, in a rate swap transaction, a fixed rate is established by the parties as a hedge. If the LIBOR rate is less than the fixed rate, the purchaser of the swap pays the bank from whom the swap is purchased the difference in the interest between the floating LIBOR-rate and the fixed rate. When LIBOR exceeds the fixed rate, the bank selling the swap pays the borrower the difference between the two rates. In some measure, rate swaps make it advantageous for banks to report lower LIBO rates, and some derivative traders have succumbed to the temptation to pressure those in their banks to artificially suppress LIBOR.
Historically, there has been little oversight or regulation of the actions of the personnel in banks participating in the establishment of LIBOR. What little control that had been exercised came from the British Bankers’ Association under whose auspices the system for setting LIBOR rested. As a result of revelations of abuses in the establishment of LIBOR in the last few years, a consortium of regulators determined to provide additional safeguards against abuses in establishing this important rate. Accordingly, as of February 3, 2014 LIBOR is and will be established under a different organization: ICE Benchmark Administration (“IBA”). The IBA has made it clear that the method of establishing LIBOR will not substantively change. Accordingly, the effect of this change on rates should be of little moment . Only the regulatory framework and oversight has changed.
Many of the loan documents currently in existence refer to LIBOR rates as set by or under the auspices of the BBA or British Bankers’ Association. Inasmuch as LIBOR will no longer be set under the BBA, those lenders will need to modify their loan documents, including those currently in existence, to refer to the IBA. Inasmuch as the announcement of the change in administration of LIBOR was made several months ago, many banks have already started the process. However, some lenders have made very little progress in affecting the change. Because of the importance of the relationship between lenders and their borrowers, it seems unlikely that the change in administration of LIBOR will adversely affect the ability of lenders to administer performing loans. However, when borrowers find themselves in difficult circumstances, they tend to look for leverage in whatever circumstances may present themselves. Accordingly, it would be wise for lenders to correct any anomalies in loan documentation created by this change in the administration of the LIBOR system.
The attorneys at Davis Miles McGuire Gardner are available to assist lenders in accomplishing these prophylactic modifications.
If you have further questions about LIBOR or banking and lending issues, please call our office at 480-733-6800 and ask to speak with Edmund Richardson. Mr. Richardson brings with him 40 years of experience in business, real estate and lending transactions and litigation.