Spread analysis (based on applicable rates per the first day of the respective months) SOFR versus USD 3-month LIBOR for May 1, 2021 – April 1, 2022. Rates derived from www.global-rates.com on April 15, 2022
The above analysis details the importance of performing a transfer pricing analysis, which should aim at replacing a LIBOR rate with a replacement rate, without a significant impact on the total applicable rate after conversion. Generally this will entail an adjustment to the spread applied over the SOFR rate. As an example: when historically a rate of USD 3-month Libor + 1% was applied, the spread of 1% is expected to be increased after transition, as the applicable SOFR rate is expected to be lower compared to the previously applied USD 3-month Libor rate. An applicable rate after conversion may in this case be as follows: SOFR rate + 1.2%.
To allow for an efficient transition, commercial tools are available in the market that can assist with the process.
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.