The Backdrop

The cessation of the London Interbank Offered Rate (“LIBOR”) post December 31, 2021 is no longer news. Yet, several market participants in India continue to drag their feet on the transition process. In the Progress Report to the G20 on LIBOR Transition Issues, the Financial Stability Board (being agency responsible for monitoring and making recommendations on the global financial system) has highlighted the concern that new lending by financial institutions referencing the LIBOR has increased the stock of contracts affected by the LIBOR transition.

In this backdrop, the Indian central banking regulator, Reserve Bank of India (“RBI”) has issued much needed directions to banks and financial institutions by its circular dated July 8, 2021 with a goal to accelerate the progress on timely LIBOR transition (“LIBOR Transition Circular”). The LIBOR Transition Circular encourages banks and financial institutions to cease, and also encourage their customers to cease, entering into new financial contracts that reference LIBOR as a benchmark and instead use any widely accepted Alternative Reference Rate (“ARR”), as soon as practicable, and in any case, by December 31, 2021. The RBI had previously as well in August 2020, requested banks to frame a board-approved plan outlining an assessment of exposures linked to the LIBOR and the steps to be taken to address risks arising from the cessation of LIBOR, including preparation for the adoption of the ARR.

On March 5, 2021 the ICE Benchmark Administration (“IBA”) notified the United Kingdom Financial Conduct Authority (“UK FCA”) that following the results of its consultation, it will no longer: i) have the necessary inputs from panel banks to be able to publish representative sterling, Euro, Swiss franc and Japanese yen settings, and 1-week and 2-month USD LIBOR settings after December 31, 2021; and / or ii) be able to publish representative settings of the other USD LIBOR tenors after June 30, 2023. Following this, the UK FCA announced the future cessation or loss of representativeness of the 35 LIBOR benchmark settings currently published by the IBA (“FCA Announcement”).

The impending transition for banks and financial institutions in India as well can therefore no longer be ignored.

RBI on Discontinuation of LIBOR

Some of the RBI’s key requirements in this regard are as follows:

• Review of LIBOR exposures – Banks / financial institutions are now required by the RBI to undertake a comprehensive review of all direct and indirect LIBOR exposures and put in place a framework to mitigate risks arising from such exposures on account of transitional issues including valuation and contractual clauses.
• Continuation of LIBOR only in certain cases – Similar to the stance taken by the UK FCA, the RBI has taken note that the continuation of certain USD LIBOR settings to be published till June 30, 2023 is primarily aimed at ensuring roll-off of USD LIBOR-linked legacy contracts, and is not to encourage continued reliance on LIBOR. The RBI has therefore advised that contracts referencing LIBOR undertaken after December 31, 2021 should only be for the purpose of managing risks arising out of LIBOR contracts (e.g. hedging contracts including transactions for hedging the consequent LIBOR exposure, contracted on or before December 31, 2021.
• Fallback and rate-switch clauses – The RBI requires banks/financial institutions to incorporate robust fallback clauses, preferably well before the respective cessation dates, in all financial contracts that reference LIBOR (where the maturity date of the contract is after the announced cessation date of the respective LIBOR settings). The RBI has also recommended reference to the standard fallback clauses developed by agencies such as ISDA, IBA, LMA, APLMA and BAFT, which have issued guidelines, fallback protocols and rate-switching clauses to accommodate the LIBOR transition. These may be used by the banks / financial institutions for risk mitigation.
• Transition away from MIFOR – As the Mumbai Interbank Forward Outright Rate (“MIFOR”) published by the Financial Benchmarks India Private Limited (“FBIL”) references the LIBOR, the RBI has also directed banks and financial institutions to cease using the MIFOR, as soon as practicable and in any event by December 31, 2021. Contracts referencing MIFOR are to be undertaken after December 31, 2021 only for managing risks arising out of MIFOR contracts. The RBI has recommended the use of the daily adjusted MIFOR published by FBIL for legacy contracts and modified MIFOR rates published by FBIL for fresh contracts.
• Fresh products referencing the ARR & Client Sensitization – Banks / financial institutions have been directed to put in place the necessary infrastructure to be able to offer fresh products referencing the ARR. The RBI has recognized and highlighted that efforts to sensitize clients about the transition (as well as the methodology and convention changes involved in the alternatives to LIBOR) will be critical in this context.

Conclusion – The way forward

With less than six months remaining for the cessation of LIBOR, the LIBOR Transition Circular by the RBI could be the driving force that is needed to ensure that at least regulated entitles take necessary actions in the evolution from LIBOR to a more well-rounded and representative alternative rate within definitive timelines. Like various other jurisdictions, India may also require further directions from its financial services regulator on the alternative rate. Legislative solutions to mitigate risk in relation to legacy contracts and to address the cessation of LIBOR may also be required, including on the replacement of the LIBOR provisions under the Master Directions on External Commercial Borrowings in India. It is crucial to recognize that while various financial agencies and banking regulators across the globe have been issuing guidelines to minimize possible market disruption due to the LIBOR transition, definitive and timely action by market participants is the need of the hour and the onus remains on such market participants to minimize the risks associated with the transition.

Authors:

This article is authored by Hufriz Wadia, Partner (hufriz.wadia@azbpartners.com) and Neeraj Nainani (neeraj.nainani@azbpartners.com). Please do not hesitate to reach out to them for any clarifications.