Lenders, LIBOR, and the move to the risk-free SOFR rate: seven takeaways for financial services firms

Business lenders and the coming LIBOR transition

Around the financial industry, executives are preparing for the end of LIBOR: the London Interbank Offered Rate. The most widely used tenors of USD LIBOR are expected to cease publication after June 2023**, and firms have been making progress in preparing to remediate derivative contracts, consumer loans, and other products tied to the widely used interest rate benchmark.

Meanwhile, business lenders have been surprisingly slow to get on board. This is arguably the slowest part of the transition away from LIBOR, even as the clock is ticking. For some time now, the Alternative Reference Rates Committee (ARRC) has suggested that business lenders should be incorporating “hardwired fallbacks” into their syndicated loan contracts and bilateral loans. These fallbacks would specify an alternative reference rate to automatically replace LIBOR if it were no longer being published for any reason. The ARRC is encouraging lenders to stop using USD LIBOR for any new business loans after June 30, 2021. And US regulators have recently issued guidance suggesting that firms should stop issuing new USD LIBOR products as soon as practicable, but in any event by December 31, 2021.

**For years, the industry has been working toward a 2021 transition away from LIBOR. But the benchmark’s administrator, ICE Benchmark Administration (IBA), recently announced that it would continue to publish some LIBOR rates — but not all — for an additional 18 months. See PwC’s LIBOR transition industry and market update for late November 2020 for more details.

Understanding the challenge

To be fair, the transition away from LIBOR could be challenging, since the ARRC’s recommended alternative reference rate (ARR) — the Secured Overnight Financing Rate (SOFR) — differs from LIBOR in some key ways.


  • As its name indicates, SOFR is an overnight rate. LIBOR is a forward looking benchmark, with terms ranging from overnight to twelve months. Market participants have gotten used to the term rate structure, and many have been clamoring for a term rate structure for SOFR. While one may develop, regulators have repeatedly cautioned against waiting for one.

  • Since SOFR is collateralized by Treasuries, it is considered a risk-free rate (RFR), without any credit premium built in. This could potentially create misalignments with lenders’ own risks: for example, during a credit crunch, SOFR might contract, reducing interest earnings just when lenders’ own funding costs may increase.


Operational issues. Financial institutions will have to adjust their own operational systems, and they’ll need to make sure their vendors have upgraded too. To switch benchmarks, companies will need to handle compounded and/or simple average calculations, shifts, lookbacks, and other convention components.

Client concerns. The industry has been anticipating this switch for years, long before the pandemic hit. Now, as lenders will need to reach out to their borrowers, they may find that many are struggling with the broader macroeconomic environment. Any move by a lender to renegotiate a contract, even to address an industry-wide issue, may be seen skeptically.

Lack of clarity. Both borrowers and lenders may rightly point out that there is no clearly defined convention that spells out how to calculate interest once LIBOR has been replaced by SOFR. With LIBOR, a borrower knows in advance what they owe because the rate is specified at the beginning of the term. As a backward-looking rate, SOFR is being calculated through a given time period, up to the point that payment is due. There are different approaches that might address this, such as a “lockout” (fixing the rate a few days before the end of the period) or a “lookback” (calculating interest over the same number of days, but shifting the start and end dates backward a few days.

While lenders may not like the idea of abandoning LIBOR, regulators in the US and around the world have made clear that its days are numbered. Fortunately, with new pricing and funding strategies, a careful approach to client relations, advance work on operational readiness, and steps to align new SOFR loans and legacy LIBOR loans, the transition can be both smooth and profitable for your company.

What this means for your business: seven key takeaways

The LIBOR-to-SOFR transition will ripple throughout the global economy in the coming months, and nearly every financial institution could need to make operational changes to be ready. And, upgrading systems may not be enough. Financial institutions will also need a strategy to ensure that they can navigate the new world of risk-free rate lending. Here are seven takeaways to guide that strategy:

Don’t count on a SOFR alternative

Even though many banks have urged that a way be found to integrate a credit risk premium into any replacement for LIBOR, at present, only SOFR has widespread acceptance as an alternative to LIBOR in the US market. While other solutions may emerge, it is unlikely that any other US ARR will gain real traction before the Fed’s transition milestones, which are fast approaching. Some market participants may eventually choose to turn to a different benchmark — and if one appears viable, you may want to explore it. But for now, there is no meaningful alternative to SOFR. With time running out, you should prepare to adopt it.

Adapt pricing strategies for risk-free rate lending

Successful RFR lending requires new pricing strategies, both to help minimize risks (especially during times of economic distress) and to manage your balance sheet. You may find that you have more options than you think when pricing SOFR-based loans (e.g. using non-zero floors), staying competitive and protecting your margin. Before the transition milestones arrive, you’ll want to have identified the new pricing strategies that fairly and transparently distribute the new risks, modeled how they might affect your particular portfolio, and then negotiated terms accordingly with counterparties.

Manage the risks to your balance sheet

When your loans are indexed to a new, risk-free rate, your funding and risk management strategies must adjust too — else mismatches could create new balance sheet risks. By changing your approach, you can create a far better alignment between lending and funding. To do this, you will need to make adjustments from a market risk and operational perspective — most likely, by moving to hedge risks with SOFR swaps rather than LIBOR swaps. It may become even harder to manage risk after the end of 2021, once all new loan production is tied to alternative reference rates such as SOFR. As LIBOR liquidity decreases in the market, there could be considerable volatility in whatever instruments remain.

Talk to your clients — carefully

To avoid reputational and conduct risk, make sure that both corporate and retail clients understand the coming changes in their legacy contracts, in the new loans you plan to offer, and in the marketplace. When communicating, take into account different clients’ differing levels of sophistication, and be empathetic: many business clients are still under great stress as they navigate the economic downturn. As with other areas, there are operational concerns to be managed, but you’ll also want to pay attention to the strategy.

Prepare for multiple SOFR conventions

For now, there’s little expectation of a uniform convention for loans based on SOFR. Different conventions — simple averaging, compound averaging, calculated with lags, shifts and lockouts — may be used for different contracts. To the degree that there is a consensus approach, we see firms gravitating toward simple interest; its implementation is likely more straightforward and it is likely more accommodating to prepayment. But you’ll want to make sure that your internal systems are operationally ready for these multiple conventions, and decide which convention you will prefer for each type of loan.

Work with vendors — and be ready with tactical solutions

Whether it’s the challenge of multiple SOFR conventions, the need to adjust platforms, accounting and reporting, or the adjustments of legacy loans, make sure that your vendors are prepared — and that their updated systems will integrate with yours. Remember that some vendors may be juggling conversions across multiple currency-tenor pairs around the world. Given the tight deadlines, you may want to develop your own tactical solutions in case your vendors’ systems are not fully operational and aligned with yours in time.

Keep going

It should be clear that there is a lot to do in a short amount of time. By now, you are likely well underway with a transition plan, and recent announcements about the final termination date should encourage you to accelerate your work. If you haven’t done much yet, the more you are able to model your potential approaches, the more likely you are to see favorable results. You’ll want to start the process now to analyze contracts and work with counterparties so that when any of your legacy LIBOR loans are transitioned to SOFR, they’ll be priced and booked appropriately.

Contact us

John Oliver

Partner, Governance Insights Center & National FinTech Trust Services Co-Leader, PwC US

Chris Kontaridis

US Deals, Strategy & Operations Leader for Tax Reporting & Strategy, PwC US

Justin Keane

Financial Services, Principal, PwC US

Jeremy Phillips

Asset & Wealth Management, Partner, PwC US

Jessica Pufahl

Financial Services, Partner, PwC US

Maria Blanco

Principal, PwC US

Gaurav Shukla

Capital Markets Strategy Partner, PwC US

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