How Credit Unions Should Prepare for the End of LIBOR (and Get Ready for SOFR)
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In 2017 the UK’s Financial Conduct Authority (FCA) announced that after 2021, the London Interbank Offered Rate (LIBOR) would be phased out. Here’s is what you need to know about changing the “world’s most important number.”
What is LIBOR?
LIBOR is a reference interest rate, a benchmark used to set other interest rates in the marketplace. LIBOR is currently the most referenced reference interest rate, which is why it is often called the “world’s most important number.”
Who does the change affect?
It affects any person or business with investments tied to LIBOR or with loans referencing LIBOR. It is estimated that more than $240 trillion in financial products are linked to LIBOR.
Preparing for the end of LIBOR (and Getting Ready for SOFR)
With the deadline looming in just over a year, now is the time to start moving and swapping rates. FASB (Federal Accounting Standards Board) has released two sets of guidance on swapping rates, ASU 2018-16 and ASU 2020-04. ASU 2018-16 offers specific advice on using the Overnight Index Rate based on the Secured Overnight Financing Rate (SOFR) as a US benchmark interest rate for hedge accounting. Whereas ASU 2020-04, simplifies how entities account for contracts that are modified to replace LIBOR.
What is replacing LIBOR?
Secured Overnight Financing Rate (SOFR) is expected to become the dominant global benchmark rate. SOFR is based on transactions in the US Treasury repurchase, or repo, market, where banks and investors borrow or lend Treasurys overnight. The Fed began publishing these alternatives rates in 2018. In addition, the Federal Reserve Alternative Reference Rates Committee has issued an implementation checklist for adopting SOFR.
Takeaways from the Fed’s SOFR adoption checklist
Establish strong internal guidance with senior executives to deliver and coordinate your institution’s LIBOR transition.
Develop programs to evaluate and advise clients on their LIBOR transition-related risk.
Create a proactive communication strategy to consistently engage and educate internal and external teams on the LIBOR transition.
Develop teams to monitor LIBOR review, evaluate and advise on LIBOR related risk and SOFR based products.
Redesign and transition existing LIBOR products to SOFR.
Create a team to monitor and control LIBOR transition risk and establish processes for ongoing LIBOR risk management.
Survey and understand the financial, client, and legal impact of transitioning to SOFR and create systems to navigate the implications of the transition.
Develop a readiness plan with your operational and technology teams to address SOFR implications to your operations, data, and technology.
Understand and determine accounting and reporting practice changes needed by the LIBOR transition.
Understand and determine any tax and regulatory reporting practice changes needed by the LIBOR transition.
For more information on the end of LIBOR and the transition to SOFR, contact us.