LIBOR Phase-Out: What Private Debt Funds Need to Know for a Smooth Transition

For over four decades, LIBOR served as a crucial benchmark for determining interest rates on adjustable-rate loans, mortgages, and corporate debt. However, due to various crises in recent years, the decision was made to discontinue LIBOR starting in 2021. This article aims to provide informative and easily understandable insights into the LIBOR phase-out and its implications for debt funds.

TransitionTimeline

In January 2022, the use of LIBOR for new loans in the US ceased and was replaced by the Secured Overnight Financing Rate (SOFR), considered a more accurate and secure pricing benchmark. Since then, the process of unwinding LIBOR from the global financial system has been gradual and deliberate, marked by several milestones. The most recent and notable milestone occurred on June 30, 2023, when the US dollar LIBOR bank panel concluded, including the overnight and twelve-month US dollar LIBOR settings.

New Benchmarks and Synthetic LIBOR

The 1-, 3-, and 6-month US dollar LIBOR settings have been designated as Article 23A benchmarks. The Financial Conduct Authority (FCA) now requires the administrator of LIBOR, ICE Benchmark Administration, to publish these settings in synthetic form. The calculation of synthetic LIBOR will utilize a methodology based on the relevant CME Term SOFR Reference Rate combined with the respective ISDA fixed spread adjustment.

Impact on Private Debt Funds

To ensure preparedness for the discontinuation of synthetic LIBOR settings by the end of September 2024, private debt fund firms need to take specific actions promptly. These actions include:

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1. Establish Appropriate Fallback Language: Firms should ensure all agreements incorporate fallback language endorsed by the Loan Syndications and Trading Association (LSTA) and Alternative Reference Rate Committee (ARRC).
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2. Assess Short-term Implications: Firms must evaluate the effects on valuations, financing, and other agreements tied to interest rates.
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3. Engage Trusted Advisors: Continued discussions with trusted advisors will help firms understand the risks and upcoming dates associated with the LIBOR transition.
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4. Understand Synthetic LIBOR Contracts: Firms should grasp the pricing differentials of any synthetic LIBOR contracts in use and devise strategies to handle further migration in mid-2024.
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5. Manage Investor Inquiries: Firms need to address investor inquiries regarding the transition starting in July 2023 and demonstrate a thoughtful plan for implementation. 

The phase-out of LIBOR has significant implications for debt funds. By following the recommended actions and leveraging the expertise of service providers like Petra, firms can navigate the transition effectively and ensure compliance with the new benchmark rates. Being proactive and well-prepared will help mitigate potential risks and ensure a smooth transition to the alternative reference rates.

How Petra Can Assist

Petra Funds Group is a leading provider of fund administration solutions to global private equity and debt funds. With extensive experience in building and operating credit operations for multinational private investment firms, Petra's debt team offers best-in-class loan portfolio monitoring processes tailored to track loan covenants, interest rate step-ups, post-closing obligations, financial reporting accuracy, overall borrower health, and other customizable needs.

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