Throughout the world, a transition is currently taking place from interbank offered rates (IBORs) to alternative benchmarks. At the end of 2021, LIBOR (London Interbank Offered Rate) - a reference point used globally for variable interest rates charged on financial products - will mostly no longer be available.
Over time, the IBORs will have to be replaced with an alternative system for determining the base component in variable interest rates. The alternative for the IBORs is expected to be several other government-sanctioned benchmarks for a Risk‑Free Rate or RFR. These benchmarks will be used for a wide variety of contractual arrangements and financial instruments containing variable interest rates.
The IBOR transition was initiated as a policy response to two developments. First, a number of traditional interest-rate benchmarks, notably LIBOR, were affected by market manipulations that severely undermined their integrity. Second, the underlying market for unsecured interbank funding experienced a marked decrease in transactions — and continues to do so — eroding the degree to which IBORs represent the funding costs of financial institutions.
The IBOR transition will not only have an impact on financial markets, as such, but may also have an impact on the intercompany pricing of loans, which often also make use of IBOR rates as a variable interest component.
Transfer Pricing considerations
As businesses begin to adapt their external financial arrangements to a world without LIBOR, they should also consider the potential impact this fundamental change could have on the arm’s length nature of their intercompany financial transactions.
Replacing LIBOR will require companies to evaluate the current LIBOR-based variable interest rate pricing on intercompany transactions. Situations may arise where intercompany financial transactions are based on LIBOR rates that have already been phased out. Companies will therefore need to consider alternative base rates to replace LIBOR in the future. These alternative benchmarks may require the application of an ‘arm’s length spread’ on intercompany financial transactions, so that neither party to the transaction is disadvantaged. There is not yet any specific Dutch LIBOR transition guidance on how to calculate this arm’s length spread, but any such analysis will need to follow the principles set forth under existing transfer pricing rules.
Following the announcement that LIBOR would be discontinued, alternative RFRs have been introduced for various currencies, such as:
- Secured overnight financing rate (SOFR) for USD
- The sterling overnight index average (SONIA) for GBP
- The Tokyo overnight average rate (TONAR) for JPY
- The Swiss average rate overnight (SARON) for CHF
- Euro short‐term rate (€STR) for the euro (replacing EONIA). EURIBOR also remains in effect.
The alternative RFRs are mostly published as overnight rates. This is a significant change compared to the LIBOR rates that are published in various terms (e.g. one-month, three-months, etc.). In order to account for the different terms of the alternative RFRs compared to the LIBOR, an analysis will need to be carried out to assess any transfer pricing impact.
Companies will also need to ensure that the changes are supported by contractual clauses in both new and existing agreements. To the extent LIBOR is referenced in existing agreements, appropriate fallback language should be included. However, companies should, where possible, avoid making changes that are so substantive that tax authorities could argue that a new loan has been issued, rather than an existing loan having been changed.
From a transfer pricing perspective, related parties should transact with one another in the same way as unrelated parties would under similar facts and circumstances. Therefore, it is useful to also look at relevant industry practices.
Various industry associations, such as ISDA (International Swaps and Derivatives Association) and the Loan Markets Association (LMA), have developed standard fallback texts for the IBOR transition. The EU Working Group has also prepared a general fallback text that can be used, but which may have to be customized to reflect the particular needs of a contract.
Given the scope of the impact of the LIBOR phase-out, it is important for affected companies to manage this transition carefully and to account for any differences between the two rates (i.e. LIBOR and new RFRs).
The recommended first step is for companies to identify intercompany agreements containing LIBOR references and modify those agreements.
Once the impacted agreements are identified, companies should develop a plan to adjust the pricing of their affected arrangements so that these are ready once LIBOR is discontinued. With about three months remaining before LIBOR is discontinued, being proactive now will help to mitigate or prevent any future disputes.
If you would like further information about and/or assistance with the Libor transition, please let us know.
Feel free to contact Mark Bonekamp (+31 6 21 20 10 41), Lennaert Mosk (+31 6 20 13 81 55), or another member of the Dutch transfer pricing team.
Please note that we also have specialized lawyers at Meijburg Legal who can assist you with the broader legal impact of the Libor transition. For more information about how to deal with the Libor transition from a legal perspective, please click here.