Home Business NewsBusiness Uncertainty over future of Libor is broadly credit negative

Uncertainty over future of Libor is broadly credit negative

15th May 18 7:21 am

Moody’s finds

The uncertainty around the phasing out of Libor after 2021 is broadly credit negative, but there is only a low chance of it leading to defaults on individual instruments, Moody’s Investors Service said in a report today.

“Ending Libor will have uncertain consequences for creditors holding existing Libor-linked floating rate bonds, some of which may effectively become fixed rate,” said Simon Ainsworth, a Moody’s Senior Vice President and co-author of the report. “The essential issue for financial market participants is that creditors will hold contracts that no longer ‘work’ as expected when Libor is retired.”

The transition of financial contracts to new – still to be fully defined – reference rates, and the impact of using benchmarks rates calculated on a different basis will have credit consequences for a broad range of financial market participants.

Key issues include potentially inadequate documentation that could lead to transactions reverting to a fixed rate; holders of Libor-linked bonds, loans or hedges receiving a different rate to the one they originally expected; and the creation of asset-liability mismatches.

The impact on bondholders will depend on the flexibility within contracts and the evolution of interest rates. Existing fallback language may result in unanticipated consequences for investors, including the risk that coupons might be lower – or higher – than if Libor were to be maintained.

For debt issuers there could be other credit negative – or positive – impacts from the second order consequences of a change in the basis of cashflows, or a credit event such as collateral posting requirements.

For structured finance transactions, the impact could be either positive or negative, partly depending on the exposure of a structure or tranche.

Despite the uncertainty surrounding future reference rates, Moody’s does not expect many defaults by non-financial corporates, financial institutions, project finance or public sector issuers as a result of Libor’s retirement. If payments of an originally Libor-linked bond became fixed, referenced a different benchmark rate, or were not made due to commercial disputes, Moody’s would likely not consider a default to have occurred.

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