News & Events
How The Libor To SOFR Rate Migration Will Impact Business Owners And Business Buyers
Jeff Snell | 04/18/2023
The London Interbank Offered Rate (LIBOR) has been the benchmark interest rate used globally for over 40 years. LIBOR is the rate at which European banks lend to each other, and it has been used to compute the interest rates on various financial products, including loans, mortgages, and derivatives. However, LIBOR is scheduled to be phased out by the end of 2021, as the financial industry transitions to the Secured Overnight Financing Rate (SOFR).
SOFR was created by the Federal Reserve Bank of New York in response to the LIBOR scandal, which revealed that banks were manipulating LIBOR rates for their own profit. SOFR is based on the actual interest rates paid in the marketplace for overnight loans collateralized by US Treasury securities, making it a more accurate and transparent benchmark for financial products. The transition from LIBOR to SOFR will have a significant impact on enterprises who use financial products linked to LIBOR, including business buyers and sellers.
Here’s what business owners and administrators need to know about the transition:
- Determining Exposure The first step for businesses is to ascertain their exposure to LIBOR. This involves identifying all loans, mortgages, derivatives, and other financial products that are linked to LIBOR – specifically any business acquisition loans. Businesses should collaborate with their banks and financial advisors to identify the exposure and assess the risks.
- Understanding the Differences Between LIBOR and SOFR LIBOR and SOFR are distinct rates, which means that financial products linked to them will behave differently. SOFR is generally lower than LIBOR, which means that businesses may see reduced interest rates on their loans and mortgages. However, SOFR is also more volatile than LIBOR, which means that businesses may see fluctuations in the interest rates on their financial products.
- Negotiating New Contracts / Amending Existing Contracts Once businesses comprehend their exposure to LIBOR, they will need to either negotiate new contracts or amend their existing contracts with their banks and financial providers. This will entail renegotiating the interest rates on their financial products, and potentially adding new clauses to address the transition from LIBOR to SOFR. Negotiations will be complex, as different parties will have various expectations for the transition. For example, borrowers may want to transition to SOFR rapidly, while lenders may want to maintain their current LIBOR contracts for as long as possible. Businesses will need to work with their financial advisors to balance these competing interests and negotiate the most favorable terms for themselves.
- Updating Internal Systems Businesses will need to update their internal systems to contend with the transition from LIBOR to SOFR. This will entail updating financial models and calculations to reflect the new interest rates, as well as making changes to accounting systems and disclosure documents. Updating internal systems will be a significant project for many businesses, and they will need to allocate sufficient resources to ensure the transition is smooth and seamless.
- Managing Risk Finally, businesses will need to manage the hazards associated with the transition from LIBOR to SOFR. These risks include operational and legal risks, as well as financial risks. For example, businesses may face legal risks if they contravene existing contracts when transitioning to SOFR. To manage these risks, businesses must clearly understand their exposure to LIBOR, communicate effectively with their banks and financial providers, and work closely with their legal and accounting teams to ensure compliance and minimize risk.
In conclusion, the transition from LIBOR to SOFR will have significant implications for business owners and buyers that use financial products linked to LIBOR. Businesses and buyers will need to work closely with their banks, financial advisors, and legal and accounting teams to manage the risks associated with the transition and negotiate favorable terms for themselves. While the transition will be complex and challenging, it also presents an opportunity for businesses to reassess their financial strategies and prioritize transparency and accuracy in their financial products.