Contractual continuity
Many legacy contracts which include references to LIBOR do not contain robust existing fall-backs. In some instances, those fall-backs are commercially unattractive – for example where the operation of a fall-back to the last available LIBOR rate that was published effectively converts a floating rate to a fixed rate. However, in other instances the fall-back will be unworkable or the implementation of the fall-back itself may give rise to disputes.
This may lead to arguments about the ability of the court to interpret contracts in a way that avoids a commercially unattractive or unworkable result. Alternatively, the court may be asked to imply terms to make a contract workable, or to allow the court to step in and perform the contractual mechanism (i.e. calculation of the relevant interest rate, based on expert evidence). However, in the absence of such contractual mechanisms, there is a very real risk of arguments that LIBOR cessation will frustrate the contract or engage any force majeure clause.
Mis-selling risks
The risks of litigation or conduct issues arising as a result of LIBOR cessation are clear both in respect of (i) the continued sale or distribution of LIBOR-linked products (e.g. where issues of contractual continuity may arise); and (ii) the transition of LIBOR-linked products to RFRs (e.g. even allowing for a spread adjustment, there will inevitably be a value transfer on transition, resulting in “winners” and “losers” and a potential incentive for claims or conduct investigations.
In addition, differences in the fall-backs for different product markets will likely create basis risk for customers who hold portfolios of products. This is because there are likely to be nuances across different product markets in both the economic effect of fall-backs and in the timing of their triggers. This will be particularly acute where one or more of products are intended to hedge other products impacted by the transition.
The uncertainty around the legislative fall-backs also creates risks for firms given the inability to understand the economic consequences of failing to amend legacy contracts, as highlighted below.
Governance and applicable senior manager regimes
The complexity of the transition process, and the inherent risk that it poses both to financial services firms and their customers, means that regulatory scrutiny is likely to be high. Firms are on notice that they are expected to have carefully designed and well-resourced project plans to manage the transition of their contracts. Accordingly, robust and clear governance arrangements for the programme, with specific internal project teams subject to senior management oversight and with external resource and expertise where appropriate, will be critical.
In particular, those institutions which operate in jurisdictions that have a senior management accountability regime (such as the Senior Management Certification Regime in the UK, the Bank Executive Accountability Regime in Australia and Hong Kong’s Manager-in-Charge and Registered Institutions Senior Manager Accountability Regimes) will need to ensure that they have effective processes in place to discharge the obligations of their senior managers under those regimes.