For years, private equity (PE) firms have roared ahead with high returns outpacing most other asset categories. But this strong performance may soon face a dip in the road, from a risk that few see coming.
The London Interbank Offered Rate (LIBOR)—the benchmark for US$350 trillion in financial contracts—is due to be phased out at the end of 2021. The end of LIBOR is one of the most sweeping structural changes in global finance in decades.
Federal Reserve and other regulators have warned about possible market disruptions if financial services firms delay their transition to the Secured Overnight Financing Rate (SOFR) and other alternative reference rates (ARRs). Such instability could jolt more than just the biggest banks and asset managers. PE firms also need to prepare for the coming shift in the foundation for credit and limit downside risk to their portfolio investments.
As the financial industry adopts new benchmark rates, PE firms confront challenges that stem from their structure and purpose:
A PE firm should consider guiding its portfolio companies through the LIBOR transition while taking a fresh look at its credit policies. For example, a PE firm is usually reluctant to see its portfolio companies renegotiate credit and risk facing disadvantageous changes. The cost of renegotiation alone could undermine returns. Yet fallback language in many current agreements does not account for the outright end of LIBOR and will probably need updating. Depending on their credit profile or loan covenants, some PE portfolio companies could be especially vulnerable to losses in any negotiations. Portfolio companies that take the initiative to begin talks about contract terms may be able to achieve better outcomes than those that delay discussions.
PE firms aiming to keep pace with their peers should work with their portfolio companies now to prepare for a smooth LIBOR transition. For many borrowers, steps could include:
Many PE firms may consider the switch to ARRs a low priority. Some firms hold companies for just three years or less and do not want to pay for a switch to ARRs at companies that they may sell before LIBOR’s end. But the impact from the transition will probably begin to hit long before 2021 and, as the issue gains attention, potential buyers may ask hard questions about how portfolio companies have prepared for the switch.
There are multiple benefits to acting now.
PwC has been working with banks, insurers, corporates and asset managers to think through how to prepare for the reference rate transition. The same principles apply to PE firms and their portfolio companies, and those that start now to help their holdings prepare for life after LIBOR may avoid a sudden stall in performance and stay ahead of their rivals.
 Quarles, Randal K. “The Next Stage in the LIBOR Transition,” Federal Reserve, June 3, 2019, accessed Aug. 12, 2019, https://www.federalreserve.gov/newsevents/speech/quarles20190603a.htm
PwC has been working with banks, insurers, corporates and asset managers to think through how to prepare for the reference rate transition. The same principles apply to PE firms and their portfolio companies, and those that start now to help their holdings prepare for life after LIBOR may avoid a sudden stall in performance and stay ahead of their rivals.PwC’s established global network of specialists deeply understands key LIBOR-impacted businesses such as:
We work with you to provide support across the entire lifecycle of the transition. Some of the key stages will include:
Private Equity Tax Leader, PwC US
Private Equity Advisory Leader, PwC US
Private Equity Assurance Leader, PwC US