"Why Libor’s demise threatens small businesses most"

From FT Alphaville:

In death as in life, Libor’s demise is seldom discussed without mentioning that the rate underpins contracts worth hundreds of trillions of dollars. Yet, as efforts to ditch the interest rate benchmark intensify, are we missing out on where the true difficulties in dumping Libor lie?

We think most of what those in the know dub “tough legacy” contracts — that is, contracts where an alternative to the London Interbank Borrowing Offered Rate (Libor) cannot easily be found — are in the cash markets. That makes up only about a fifth of total assets underpinned by Libor with the balance derivatives. While the derivatives market has its own challenges, its financial sophistication has meant it’s in a far stronger position in preparing for transition. By focusing more on the overall size of the market, we’re underestimating the massive implications the death of Libor will have on lending to businesses — especially smaller ones.

Why Libor is so difficult to replace
Teams of bankers, lawyers and corporate treasurers around the world are spending a large part of their time tearing their hair out trying to transition in time for Libor’s death on December 31 2021.

That might sound like long enough to the uninitiated but, believe us, ditching Libor is such a quagmire that 15 months is, if anything, way too little time. Bear in mind that this in an exercise that has been dubbed a “DEFCON 1 litigation event” by the New York Fed’s chief legal counsel Michael Held and “a bigger problem than Brexit” by various lawyers and bankers we talked to.
The issues range from the bureaucratic to the philosophical.

The pain for any bank or business begins with trying to work out where their many exposures to the rate lurk. This is no easy task. Libor has provided the bedrock for the floating-rate market since the 1980s, is frequently called “the world’s most important number” and, more than a decade after a massive scandal, still underpins hundreds of trillions of dollars’ worth of contracts.

Once those exposures are found, the real fun starts (if fun is measured in corporate law billings, that is). Contracts must be scoured for what is known in the lexicon as “fallbacks” — legal rules that spell out what would happen in the event Libor ceased to exist. Many of those fallbacks in their current state, however, fundamentally change the nature of the relationship between the borrower and the lender.... 

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