Contract Lifecycle Management: The Financial Service Industry’s Secret Weapon For Managing The LIBOR Transition
Embedded in as much as $340 trillion worth of financial contracts worldwide, LIBOR (London Inter-Bank Offered Rate, also known as IBOR) has been the de facto interest rate for decades. But with the end of 2021- and the cessation of LIBOR fast approaching – the scramble has begun to identify and adopt new interest rate benchmarks.
While work is being done to understand how new rates like SONIA and SOFR will impact financial considerations, not enough has been said about how legal departments should respond to the change. This is disconcerting, as the impact of LIBOR primarily will be felt through an organization’s contracts.
As of January 2020, Forbes reported that only three percent of organizations had effectively prepared to move away from LIBOR. For Legal, this statistic should trigger an alarm, as the workload of LIBOR has the potential to bury a company in risk and costs. According to John Heltman at American Banker, 14 of the top world banks anticipate spending in excess of $1.2B to address the LIBOR transition.
What can you expect as the LIBOR transition hits? Lots and lots of busywork. The impact will be tremendous and has implications across the entire contract lifecycle. If you’re in Legal, and need help explaining the impact LIBOR will have on your department, here are three reasons why LIBOR presents a unique and serious challenge.
Three Challenges The LIBOR transition will create for Legal
1. Almost every current contract will need to be reviewed
Because LIBOR impacts everything from corporate and municipal bonds and loans, to floating rate mortgages, asset-backed securities, consumer loans, interest rate swaps, and other derivatives, it will force most financial services companies to review every contract to understand the full scope and impact of a LIBOR transition.
No matter how many contracts you manage, manually identifying active and inactive agreements, abstracting relevant contract provisions, understanding what contract types need to be most closely evaluated, and determining if and where fallback provisions need to be established will require a Herculean effort.
2. The “last-minute” rush to update contracts with Alternative Reference Rates will force a lot of 11th-hour reviews
In order to streamline LIBOR as much as possible, all new contracts should ideally include alternative reference rates. This way, the work being done today doesn’t add to the volume of work that will need to be done as part of the LIBOR transition.
Unfortunately, as there is still no obvious alternative to LIBOR, most contracts that are created today will not include a preferred alternative reference rate. This means, every contract created today should be seen as transitional and will need to change mid-term or be reset with new rates in January 2022.
Even as alternative reference rates are agreed upon, there still will be a fair amount of effort to identify a transition path, especially since many legacy contracts don’t have recommendations for fallback clauses. Legal resources must be reserved for supporting companies through periods of uncertainty or disagreement over how contracts should be interpreted, and handling the fallout of the adjusted rates are not aligned with the expectations of the affected parties (i.e. if the replacement materially changes the total effective rate.)
3. Global contracts, non-standard contracts, and third-party contracts will introduce high levels of complexity to the review process
Currently, it seems that proposed alternative rates will be calculated differently across geographies, which means all existing payments under contract may need to be reevaluated in detail—especially if agreements are global, subject to a variety of replacement rates, or in some cases, replacement rates are not suitable for the contract.
Uncovering the vast opportunities and risks buried within hundreds or thousands of agreements requires cognitive technologies, like Natural Language Processing and machine learning to automate repetitive, rules-driven processes and identify exceptions.
Additionally, non-standard clauses and contracts on third-party paper require additional reviews, and the transition path may vary by party. Just the red-lining process and multiple back and forth communications make this task incredibly time consuming and potentially fraught with human error.
Contract Lifecycle Management Makes LIBOR Manageable
Navigating the challenges introduced by the LIBOR transition will require Legal teams to make big changes to the way business is done. With so much complexity and uncertainty, the only way to stay afloat is to leverage technologies-like AI-enabled contract management systems-to do the heavy lifting of analyzing documents, spotting impacted clauses, and making mass updates to language as alternative reference rates are defined.
CLM aids the LIBOR transition by enabling legal teams to:
– Identify contracts with LIBOR linked terms or rates
– Consolidate all contracts into one place
– Digitize contracts by extracting key clauses and metadata
– Uncover exceptions automatically
– Identify language that needs to be changed using machine learning
– Identify where amendments should be made
– Standardize the clause library with preferred and fallback provisions
– Automate workflows and monitor progress dashboards
By bringing automation to the contract lifecycle, Legal resources are freed up to focus on some of the more nuanced aspects of the LIBOR transition and guide organizations through the transition in more meaningful ways.