By the end of 2021, many companies will have stopped using the London Interbank Offered Rate, or Libor, in their contracts, although some reports suggest overnight, month, six-month and one-year Libor rates could. will continue to be published until June 2023.
The benchmark rate has long been used to set the value of interest on loans and lines of credit, calculated by averaging the rates charged by several UK banks when lending to each other. Unfortunately, during the 2008 financial crisis, it was discovered that some large banks could manipulate Libor, a move that had serious consequences, so changes were triggered.
At first glance, this scenario might be seen as a problem only for the financial sector. However, all types of businesses realize that they have significant exposure due to the Libor. The rate is used in contracts between functions, internal processes and systems, leases, purchasing, financing, pension plans and more.
Libor-based contracts will now have to reference other interest rates. The Secure Overnight Finance Rate, or SOFR, has been recommended as a replacement for the USD, although it is not the only alternative rate. Yet the question remains, what happens to contracts when the interest rates received, or offered, are based on Libor? It is important to understand the financial impact on your organization that removing Libor will have. While changes to payment terms may be necessary, in some cases entire agreements could be compromised.
Unanticipated large-scale changes like the Libor transition often present enormous challenges for businesses and their legal teams and require legal teams to make deals to accommodate potential changes, especially when it comes to critical arrangements involving a financial contribution.
Feel the pressure
There’s no getting around this: Legal teams and corporate counsel will need to review every financial deal in their contract portfolio and identify Libor credentials. Since contracts are frequently scattered throughout an organization, not only can they be difficult to find, but performing the analysis to calculate the actual exposure is likely to be very difficult. This analysis will require much more than a simple search for the term “Libor” in the documents.
It is important to understand how contracts handle changes in Libor, as well as any other fallback benchmarks. Are there provisions dictating a replacement rate when a benchmark like Libor expires. Does the end of Libor as a benchmark rate make determination of payment impossible, impractical, or lead to an outcome neither party intended? Legal teams are likely to find themselves renegotiating existing contracts that lack fallback language or contract changes for new clients.
With a traditional approach, significant resources and employee time would be consumed for a Libor review of all contracts. To add to the pressure, the teams have set Dec.31 as the deadline to do so. For contracts that extend well beyond the end of 2021, the lessons learned from the Libor extinction should be taken into account when entering into new commitments based on a benchmark or benchmark rate. another floating point. This involves identifying the provisions likely to be affected by actions beyond the control of either party and attempting to put in place a process in the agreement to manage any impacting change.
It’s different with digital
Until you know where Libor crosses a business, every financial deal should go through the legal team for review. Digitizing contracts can dramatically speed up the review process, as the legal team focuses on understanding Libor exposure and reducing processing costs, while strengthening agreements and negotiating positions. Digitization of contracts helps legal teams quickly identify Libor-related issues – and many other similar issues that may arise in the future – and offers additional benefits such as discovering patterns in transactions, improving efficiency. ‘risk analysis and facilitation of accounting and compliance reviews.
The difference that digitalization makes is huge. However, this is only the first step; you still have a mountain of details to organize before the information becomes useful. Many legal teams find a solution in contract lifecycle management platforms with analysis tools. Capable of harnessing digital information, these deliver the speed, nuance and precision needed to address the end of the Libor effectively, both cost and operationally. Technology can quickly analyze and identify key components of your existing contracts, support writing better agreements, and centralize resources, all while enabling peers to collaborate at every stage. Ideally, platforms should use AI to produce more powerful information, automate tasks, and deliver better results in less time.
With the right contracting platform, legal teams can quickly identify all legal agreements that mention Libor, with personalized reports allowing sorting and categorization of each. He can distinguish between loans taken out and sales contracts offered. Teams can also easily see which contracts include key provisions that can help you spot opportunities and mitigate risks associated with major global changes like the Libor transition. Having solid technology that can help you identify the key agreements and provisions that you need to focus your efforts on will save you countless hours and help you achieve a more beneficial outcome for the business.
Legal teams need modern contract management capabilities to keep pace with today’s digital world. With limited talent, technology can enable staff to do more than ever. The right contract management platform is a valuable tool to help you spend your time providing high-value analysis and anticipating potential issues, and will increase the quality of service you provide to your organization.
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Tim parilla is the CLO of LinkSquares, the fastest growing AI-powered procurement platform for legal teams. Named Gartner Cool Vendors 2020 for contract lifecycle management and advanced contract analysis, LinkSquares is used to drive business forward by more than 400 legal teams in mid to large sized businesses, including brands such as TGI Fridays, Cogito and Wayfair.
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