The transition from LIBOR: What is new in 2022  

At the end of 2021, we introduced you to the transition from the Interbank Offered Rates (“IBORs”), including the most popular one – the London Interbank Offered Rate (“LIBOR”) to the Alternative Risk-Free Rates (“RFRs”). Our previous article on this topic also focused on the consequences of that historical change in light of transfer pricing and commercial relations.   

Following the end of 2021, the plans for the LIBOR transition have not changed - they have been put into motion. Most LIBOR tenors have ceased to be published since 31 December 2021. Other popular tenors of USD LIBOR will continue to be published but will cease or become unrepresentative on 30 June 2023 and some GBP while JPY LIBOR tenors which were deemed permanently unrepresentative will continue to be published for a limited period of time on a synthetic basis.

Here are some key highlights as of March 2022:

The synthetic LIBOR

The International Capital Market Services Association (“ICMSA”) published their bulletin about synthetic LIBOR, Type 1 fallbacks and dealer poll mechanisms(1). With the bulletin, the ICMSA has sought to highlight key areas of operational difficulty faced by its members when operating legacy LIBOR-derived interest determination and fallback mechanics. The main focus is on support initiatives with the aim to clarify when reference banks will or will not be in a position to respond to dealer polls.

The Bank of England, Financial Conduct Authority (“FCA”) and the Working Group on Sterling Risk-Free Reference Rates issued a joint statement, detailing the remaining steps to be taken to finalise the end of LIBOR rates(2). They reported minimal disruptions in the market but encouraged participants to continue working towards the active transition of legacy sterling LIBOR contracts currently using the temporary synthetic LIBOR. The FCA stated that synthetic LIBOR is a temporary bridge to RFRs, and the authority cannot guarantee its availability beyond the end of 2022. In 2022, the FCA will seek views on retiring 1-month and 6-month synthetic sterling LIBOR at the end of 2022, and on when to retire 3-month sterling synthetic LIBOR (without indicating a time frame for the latter).   

The rising of the interest rates

In light of the LIBOR transition, the Internal Revenue Service (“IRS”) in the U.S. published the long-, mid- and short-term Applicable Federal Rates (“AFR”) for March 2022(3). It is reported that the AFRs have registered an increase of almost 70% since last December. The AFRs are an important benchmark since they provide the so-called “safe harbour” for US tax purposes. The safe harbour guarantees taxpayers that when its conditions are met, tax authorities are obliged to accept the rates applied by the parties in respect to transfer pricing considerations. With the end of LIBOR, their significance has increased. Many multinational groups systematically rely on the AFR to benchmark the loans they give to their European related parties. In European jurisdictions where interest expenses have been accrued for tax purposes, the low quantum does not create a transfer pricing exposure. With the recent increase in AFRs and the likelihood that this trend will continue, multinational groups will need to do an economic analysis in order to maintain the arm's length nature of such interest rates.

(1) https://www.icmagroup.org/assets/documents/ICMSA-BULLETIN-220119_59-Synthetic-LIBOR-Type-1-fallbacks-and-dealer-poll-mechanisms_.pdf

(2) https://www.bankofengland.co.uk/news/2022/february/sterling-risk-free-reference-rates-finalising-libor-transition

(3) https://www.irs.gov/applicable-federal-rates