CFO Intelligence Magazine – Fall 2022

Mark D. Mishler

MBA, CPA, CMA

LIBOR (London Interbank Offered Rate) is the ubiquitous reference interest rate incorporated into contracts amounting to $350 trillion worldwide. It has been used in both lending and borrowing contracts since the mid-1980s.

Beginning in 2022, U.S. companies were no longer permitted to enter into new LIBOR referenced contracts, though some LIBORs will still be published until June 2023 to support legacy LIBOR contracts. LIBOR must be replaced by different alternative reference interest rates. In the U.S., the leading replacement is the Secured Overnight Financing Rate (SOFR).

To the uninitiated, this change from LIBOR may appear to be a problem limited to only banks and financial companies. But most companies, including manufacturers and other nonfinancial companies, have LIBOR exposure. Reference interest rates are incorporated into contracts impacting business functions, internal processes, and information systems. Examples are loans, leases, financial securities, derivatives, accounts receivable contacts, purchasing contracts, transfer pricing, intercompany funding, pension plans, accounting processes, and risk management.

LIBOR’s shortcomings surfaced during the global financial crisis around 2008, since it is derived from hypothetical — not market-based — borrowing transactions submitted by a few banks, which do not constitute an active market. This means LIBOR was not supported by an active market of observable transactions by market participants, which are critical terms for determining fair value and are identified in FASB Topic 820, Fair Value Measurement.

SOFR is the leading reference interest rate replacement in the U.S. SOFR meets these marked-based criteria; but SOFR has its critics since it does not have a forward-rate component.