In 18 short months, Libor (London Interbank Offered Rate) is going away. The financial services sector has been furiously assessing their contractafs and finding their risks, with an estimated two in every five contracts referencing Libor having no language to deal with its demise.
While there is a lot of effort going into this essential contract review, now is the time to think about the end game: how will you take the contracts that you’ve entered into over many years and remediate them in just 18 months?
Managing this enormous endeavor efficiently and accurately will require large financial institutions to demonstrate an elusive mix of agility and process discipline. Large banks will have to simultaneously determine replacement rates and required contractual changes while commencing client outreach and putting in place complex internal project governance and coordination mechanisms.
The process is not wholly unlike previous repapering initiatives in the context of the Alternative Investment Fund Managers Directive, Fair and Accurate Credit Transactions Act, Margin Reform and other regulatory changes. In short, smart preparation upfront pays big dividends—avoiding confusion, excessive expenditure on outside counsel, wasted cycles, and a poor experience for both internal stakeholders and counterparties. Here are six steps to help guide you to a successful Libor transition.
Six key steps to a successful Libor transition process for your contracts:
Getting your arms around the scope of the project is one of the first steps in setting up a Libor transition program. Contract collation and review is the key to understanding this scope. While you may be able to quickly identify contracts that always rely on Libor, a discussion with stakeholders across multiple desks will likely reveal subsets of documents that use it occasionally, or as a fallback or alternative rate. There may also be related documents that are triggered by rate changes in the documents that use Libor, or others that have hedging mechanisms based on it. The review process itself will likely reveal still more documents that indirectly impact, or are impacted by, moving away from Libor. If this sounds like a detailed, extensive piece of the process, you’re right. What will take even longer? Not doing this up front—and instead chasing new documents, re-reviewing for overlooked clauses, and multiple conversations with stakeholders, which is far more painful and will ultimately slow your ability to amend your contracts.
You’re obviously going to want to keep stakeholders and other interested parties abreast of the progress you’re making generally, the status of specific agreements, and any delays or other real-time changes. But you need to find out specifically what management information is important to those receiving the report. What data matters most to them? How often would they like it reported? In what format? Remember, legal and contracts are only streams within what is likely an enterprise-wide program of transition making it vital to consider how your reporting becomes part of overall project health. Take time early in the process to have conversations with the relevant people, Then you can proceed with confidence that you have all the documents you need, and are reviewing all the inputs that you require, to meet reporting expectations.
Once you understand the management information requirements, you can build that into your workflow. You will have a sense of the scope of the work once you’ve collected the documents and identified the information necessary to review and repaper the contracts. You will know what your reporting requirements are as you assemble the results of your review, and you can build that reporting into your workflow to maximize efficiency. You want a workflow that is centralized, yet nimble enough to use across desks. Operational processes will have to be agile, adjusting as the project, internal systems and markets develop, but a well-defined workflow will make adjustments smoother and less disruptive.
Just as you want to organize and consolidate outreach internally, you also want to limit how much you reach out to counterparties. Where practical, try to establish a single point of contact that can respond to the counterparty across multiple desks and product lines. Try to consolidate your communication and negotiations into as few contacts as possible to avoid frustrating your counterparty (especially if they’re also your client). The cleaner and simpler the experience, the better. Consider it leverage, if you will—a straightforward, positive, transparent negotiating process is a pleasant one. And a happy counterparty is (hopefully) an amenable one.
Assemble your playbook at the project outset—outlining your negotiating parameters, decision rules, and escalation/approval protocols. If you can’t determine beforehand how to resolve specific situations, you can still establish the process for decision-making. You’ll undoubtedly have to update negotiating guidance in real time as the market comes together around new norms, especially as you determine the alternative rates you’ll apply, but having codified rules of play from the start will make those tweaks organic yet not chaotic. And just as key to writing it down, is sounding it out—make sure you have buy-in from all the relevant parties, with coordination between the business and legal teams. This is where a highly capable third-party provider can be useful—you don’t have to reinvent the wheel as they should have materials and methodology that can be tailored for your specific requirements.
Your process doesn’t just include what you need, but who will do it. Getting through a large and complex body or work will require the right mix of skills and seniority levels. How many senior subject matter experts do you need versus midlevel banking lawyers versus juniors or paralegals? What can an alternative legal service provider offer versus internal teams? Are there particularly unique or complex agreements that need outside counsel? Identifying and assembling who you need—not who you can get at the last minute—means you leverage key relationships, benefit from specialties and enjoy other personnel-specific advantages. It’s easy to end up with a top-heavy team that is more firepower (and more expensive) than you need, or a bottom-heavy team that isn’t best suited for the judgement calls required.
There is a lot of focus on identifying and collecting the impacted contracts and reviewing the relevant clauses. That’s a critical first step, and it makes sense for it to get the most attention. But all that is about understanding scope and assessing risk. The end game is resolving, or at least mitigating, that risk. The time and energy devoted to outreach, renegotiation and repapering can’t be underestimated. And preparing for that upfront can make the difference between a chaotic and expensive outcome, or a smooth and efficient one.