Paul Brehony and Simon Fawell discuss latest Libor ruling in Banking Risk & Regulation

A landmark court ruling gives trading desks some clarity on how alternative rates may fill the void left by Libor, but it does not set a hard and fast rule. Don’t assume that all disputes will end the same way.

The London Interbank Offered Rate officially ended on September 30. This brought to an end one of the most complex transitions for financial markets in the past decade. What comes after Libor?

Despite efforts by banks to manage a voluntary transition to an alternative, many instruments are still pegged to the now-defunct rate. The crucial question is: what happens to these trades now? Can a new rate be imposed (and if so, what) or must the instrument be redeemed?

For close to 40 years, trillions of dollars’ worth of financial instruments were tied to Libor with little thought given to what would happen if the rate became extinct . Its demise, after some of the world’s biggest banks were exposed for fixing the rate, has created significant uncertainty for heads of trading. A new court judgement has provided some guidance for the first time.

Last month, the English High Court handed down its much-awaited judgement in Standard Chartered PLC v Guaranty Nominees.

The case was, essentially, about how Standard Chartered pays its shareholders. The dividends for Tier 1 preference shares, issued in 2006, were pinned to an interest rate linked to the nowdefunct three-month USD Libor.

However, its relevance goes far beyond shareholders and this type of instrument. The new ruling is highly relevant for traders or anyone dealing in financial instruments pegged to Libor-based floating interest rates.

Standard Chartered won this round in the ring

The bank succeeded in its bid to replace the former benchmark with a daily rate from the Federal Reserve Bank of New York and said the judgement provided “clarity” about alternatives to Libor.

The case was about shares, but the court made it clear that its reasoning could apply to other financial products which also reference Libor. There was a clear indication that, for debt instruments, phasing out Libor does not automatically mean they need to be redeemed . Instead, a new rate will be applied.

While it will depend on the contract’s fine print, the ruling makes clear that, in most cases, where trades are still pegged to Libor, an objectively reasonable alternative rate will be applied. If the parties cannot agree on a rate, the court will impose one.

The court did impose an alternative rate in this case . Moreover, its willingness to endorse the use of three-month CME Term SOFR, plus the three-month spread adjustment, as a replacement for three-month USD Libor, suggests it would do the same again in similar cases.

The court also effectively put paid to arguments floated previously in the market that fallback provisions commonly found in contractual wording should kick in. Those provisions generally state that, where Libor is not published on a particular day, the last published rate should be used. If applied to Libor ending permanently, that would effectively convert a floating rate instrument into a fixed one. The court acknowledged, though, that this type of provision was designed to deal with a temporary unavailability of Libor and should not be used in the event of its demise.

Banks should still expect pushback

While there is still scope to argue some of the finer points, the court’s ruling does provide more certainty for trading desks on what to do with trades pegged to Libor where no voluntary transition to an alternative rate has been agreed.

However, it is important not to make assumptions. Each case will depend on the terms of the contract in question and banks should still expect legal challenges. In particular, the position may well be different for contracts entered into at a time when it was well-known that Libor would come to an end but the parties nevertheless selected a Libor rate.

One key issue may be that the court left open the possibility that, while spread-adjusted SOFR was the most objectively reasonable alternative rate for now, that could change over time. However, the broad consensus is that, while imperfect, the SOFR rate imposed by the court is currently the most reasonable substitute, which suggests that challenges of this type are unlikely in the near future.

Traders should take heart from this judgement, but be wary of relying on it in every case.