NEW YORK, July 27 (Reuters) - The head of Britain’s financial markets regulator said a substitute for the London Interbank Offered Rate (Libor) must be in place by the end of 2021, presenting a challenge for the US$925bn US leveraged loan market, which pegs its interest payments to the rate.
Libor, set by submissions from banks based on the rate they believe they would be charged for borrowing, is a lynchpin in the US leveraged loan market, which lends to companies to back acquisitions. While many loan credit agreements allow borrowers to set their payments to a base rate, companies stick with Libor, typically choosing a one- or three-month contract.
The Loan Syndications and Trading Association (LSTA) said in a July note that if Libor were to go away, new credit agreement language would have to be developed for a replacement and that industry discussions were just beginning.
“The LSTA will remain engaged in this issue and, as any replacement rate is firmed up, will work with our members to avoid market disruption, ensure orderly transition to the new rate and develop appropriate language for credit agreements,” Meredith Coffey, executive vice president of research and analysis at the LSTA, said in an e-mailed statement.
Andrew Bailey, chief executive officer of the Financial Conduct Authority, said Thursday that work must “begin in earnest” to shift to a Libor alternative, Reuters reported. Bank of England Governor Mark Carney has said that reference rates should be based on market transactions not judgments.
Bailey said that Libor must be replaced because there are not enough transactions underpinning the rates, Reuters reported. Libor has been in the spotlight following allegations bankers were manipulating the benchmark.
Three-month Libor has risen 115% since the start of 2016 to 131bp Thursday after staying below 25bp for the last few months of 2013 through to the start of 2015.
The largest buyer of leveraged loans, Collateralized Loan Obligations (CLOs), also sets the interest rate it pays investors to Libor.
Market participants said new or expanded risk factors will likely be included in future CLO deal documents about the elimination of Libor. Many CLOs currently have a mechanism for an alternative rate to be chosen if Libor is unavailable. (Reporting by Kristen Haunss; Editing By Michelle Sierra and Jon Methven)