- Alternative reference rates are gradually replacing Libor in new contracts but it is still being used, so associated risks persist
- Some existing contracts will likely prove incapable of transition, particularly in structured finance
The London Interbank Offered Rate (Libor) will likely be discontinued at the end of 2021, but other market standards and issues remain unsettled, exposing issuers and investors across many sectors to uncertainties and potential credit risks, Moody’s Investors Service said in a report recently.
“Alternative reference rates are gradually replacing Libor in new contracts, but it is still being used in the global financial system, so associated risks persist,” said Anthony Parry, Senior Vice President Manager at Moody’s. “Still, for new Libor-linked contracts, transition risks are largely mitigated by the presence of standardized fallback language.”
“Requirements to establish market standards and sufficient liquidity remain the biggest obstacles to greater adoption of alternative reference rates. Some market participants are reluctant to be the first to more aggressively end their use of Libor at the risk of their market sector ultimately favouring different standards.” Moody’s said.
“Without fuller resolution of remaining issues, both new and existing Libor-linked contracts face a growing likelihood of credit negative effects. These could range from more manageable issues such as increased costs and inadequate hedging, to more material and difficult to quantify risks, such as from contracts failing to transition to alternative benchmarks at all when Libor is discontinued.”
“One possible result is that contractual obligations effectively convert to a fixed rate by forever referring to the last published Libor rate on the day of withdrawal. The likelihood of parties turning to the courts to resolve transition-related disputes will grow, increasing costs and leaving parties exposed to uncertain outcomes and reputational risks. Some existing contracts will likely prove incapable of transition, particularly in structured finance,” Moody’s added.
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