Legal Update | LIBOR Transition in the Indian financial system
Co-authored by Jhinook Roy, Partner and Junaid Lirani, Associate
In the backdrop of UK’s Financial Conduct Authority (“FCA”) announcing in March 2021, that the London Interbank Offered Rate (“LIBOR”) would either cease to be provided by any administrator or would no longer be considered a representative rate, the Reserve Bank of India (“RBI”) notified banks and financial institutions asking them to take necessary steps to transition away from LIBOR. With RBI’s alerts being issued as early as August 2020 requesting banks to frame board-approved plans to take steps addressing the risks of cessation of LIBOR and adoption of Alternative Reference Rates (“ARRs”), the transition appears to have reached its final stage. On 12th May 2023, RBI notified banks and financial institutions to implement systems for transition from LIBOR with effect from 1st July, 2023[1]. Read with the earlier notification of RBI dated 8th July, 2021[2], the recent notification focuses on the following:
1. Cessation of US dollar LIBOR:
After 30th June, 2023, the remaining five US dollar LIBOR settings will no longer be published. Synthetic LIBOR settings may continue to be published, but they shall not be used in new financial contracts. This is in line with FCA’s clarification that these settings are not meant to be used in new financial contracts. On 3rd April, 2023, the FCA announced that publication of the 1-month, 3-month and 6-month US dollar LIBOR settings will be continued for a short period after 30th June, 2023, using an unrepresentative ‘synthetic’ methodology[3]. However, from 1st July, 2023, after the US dollar LIBOR panel ends, all new use of synthetic US dollar LIBOR will be prohibited.
2. Cessation of MIFOR:
After 30th June, 2023, the Mumbai Interbank Forward Outright Rate (“MIFOR”) benchmark, which relies on US dollar LIBOR, will no longer be published by Financial Benchmarks India Private Limited.
3. No new transactions using US dollar LIBOR or MIFOR:
RBI has advised banks and financial institutions to ensure that they and their customers do not enter into new transactions using US dollar LIBOR or MIFOR.
4. Fallback provisions:
Noting that there have been instances where financial contracts linked to LIBOR are yet to accommodate fallback clauses, RBI has asked banks and financial institutions to promptly insert such clauses in remaining legacy contracts referencing US dollar LIBOR / MIFOR, to ensure a smooth transition well before the deadline of 30th June, 2023. Relying on synthetic LIBOR rates as substitute for fallbacks in legacy contracts is discouraged by the RBI. Banks and financial institutions have been encouraged to incorporate robust fallback clauses in all financial contracts referencing LIBOR and maturing after the announced cessation dates. Fallback clauses are expected to provide a suitable alternative rate once LIBOR becomes unavailable or non-representative. Standard fallback clauses developed by various agencies such as the International Swaps and Derivatives Association, Indian Banks’ Association, Loan Markets’ Association, Asia Pacific Loan Markets Association, and Bankers Association for Finance & Trade may be referred to for this purpose. Typically, fallback clauses in contracts provide a mechanism to arrive at a replacement rate if a benchmark rate is discontinued, becomes non-representative or unavailable.
5. Complete transition by 1st July, 2023:
In line with international regulators, RBI has urged banks and financial institutions to have systems in place to completely transition from LIBOR from 1st July, 2023. Sensitisation of customers about steps undertaken to manage the risks of is expected to aid in a smooth transition.
6. Adoption of Alternate Reference Rates:
With the cessation of LIBOR, banks and financial institutions are required to adopt widely accepted ARRs such as the Secured Overnight Financing Rate (SOFR) and the Modified Mumbai Interbank Forward Outright Rate (MMIFOR). While many institutions in India have already transitioned to ARR, RBI’s recent announcements suggest that some are yet to make the transition. Many Indian banks have published advisories to their customers and formed working groups to assess the impact of the transition to ARR, given it may have taxation, accounting, legal and operational impact.
Conclusion:
The cessation of LIBOR has been expected for many years now, and most institutions are likely to have plans in place to ensure a smooth transition away from LIBOR. Many Indian banks commenced execution of ARR-linked transactions as early as January 2021. The two high-priority remedial measures for banks and financial institutions to effectively transition away from LIBOR, seem to be to educate their customers on its impact considering that LIBOR and ARR are quite different (the former being forward looking term rate and the latter being overnight interest rate) and contract remediation. Many Indian banks have also highlighted that some contracts do not contain adequate fallback provisions, in which case, such contracts would need to be amended to incorporate a fallback as advised by RBI or if feasible, renegotiate or close the contracts. The LIBOR transition is undoubtedly one of the most impactful developments in the history of financial markets across the world, given the global outreach of LIBOR. In the Indian context, the LIBOR transition will have significant impact on financial products including bonds, derivates, structured financings and external commercial borrowings.
[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12503&Mode=0
[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12128&Mode=0
[3] https://www.fca.org.uk/news/news-stories/fca-announces-decision-synthetic-us-dollar-libor