IBOR transition, reconsideration of intercompany financing transactions is required

Because of the financial crisis and the LIBOR scandal, a global project to reform interest benchmark rates has started in 2013. Several existing interbank offered rates (IBORs) such as the Euribor and LIBOR are in the process of being renewed or phased out by the end of 2021. Companies that use these IBORs for the pricing of their intercompany financial transactions should evaluate the impact of the transformation and prepare a clear transition plan.

Currently, alternative reference rates such as SOFR (US), SONIA (UK) and ESTER (Europe) are in the process of being developed and implemented. Alternative reference rates may differ per region, currency, tenor, and basis. In general, these rates differ from the traditional IBOR rates on one or more of the following aspects:

·         Collateralization

·         Tenor

·         Data used (historical vs. forward-looking)

For example, SOFR is collateralized by US treasury department and most of the alternatives for the IBOR are overnight reference rates while the LIBOR is published with a range of seven maturities up to a year (1 year LIBOR for example). Finally, the alternatives are based on actual historical data instead of assumptions/expectations of a panel of large banks on which the LIBOR is currently based.

Considering the differences between the IBORs and the alternative reference rates, it seems not appropriate to simply replace the IBOR with the respective alternative reference rate for the pricing of intercompany financial transactions. Especially since the alternative reference rates and the existing IBORs will most likely differ in outcome.

Basically, there are three scenarios to consider for your intercompany financial transactions. Each of these scenarios requires a different approach.

Loans that are repaid in full before 31 December 2021

For existing loans which expire before 31 December 2021 there is no real issue as long as the current IBOR is still being published and the calculation of the current benchmark rates do not change.

Existing loans that are still active after 31 December 2021

Action is required for existing loans that expire after December 2021. MNEs should assess the exposure and impact of the IBOR transaction and decide on how they want to deal with this exposure (risk management). An option may be to immediately adjust current intercompany agreements to include specific wording on this transition. An alternative is to wait until more market data is available to better assess the actual impact of this transition.

Overall, it is well advised to document the company’s assessment of the impact of the IBOR transition and the chosen strategy to tackle this issue. This may help mitigate the risk on later discussions with tax authorities.

New loans issued before 31 December 2021

When new intercompany loans are issued before 31 December 2021, there are several options to deal with the IBOR transition. If the company still chooses to set a floating interest rate, they should include a fallback clause in the intercompany agreement. This fallback clause should address what alternative reference rate will be used after the IBOR transition and how the change in benchmark rate will be implemented (i.e. which adjustments should be made to the applied spread in order to account for the differences in base rate). This can either be a very descriptive fallback clause that also includes specific data on the potential spread adjustment, but it can also be a more general statement that the spread will be renegotiated at the moment the applied IBOR is phased out or renewed.

Other alternatives to tackle the IBOR transition are applying the new base rate now (if the data is available) or considering a fixed interest rate instead of a floating rate. 

Conclusion

MNEs should prepare for the IBOR transition and assess the impact of this transition on their intercompany financial transactions. It is well advised to also document this assessment and the chosen strategy to tackle the IBOR transition, as this may help the company with potential future discussions with tax authorities.

If you need help assessing and documenting the impact of the IBOR transition on your company or would like to know more about this topic, please feel free to contact us via your Quantera Global contact person or info@quanteraglobal.com.

 

 

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