The London Interbank Offered Rate (LIBOR) is the global benchmark for financial transactions with an estimated volume of USD 370 trillion. The discontinuation of LIBOR at the end of 2021 requires market participants to use alternative key interest rates from 1.1.2022 at the latest.
This amendment affects the transfer pricing systems of multinational enterprises (MNEs) that have entered into intercompany financing agreements on the basis of LIBOR. Stakeholders should assess the impact on existing intra-group transactions and policies in a timely manner and develop a transition scenario that takes into account the likely impact of discontinuing LIBOR.
Alternative interest rates have emerged in various countries, but their characteristics differ significantly from LIBOR according to region, currency, maturity and basis.
In the USA, the Secured Overnight Financing Rate (SOFR) introduced by the Federal Reserve in 2018 is establishing itself. The SOFR is based on the interest rate for banks that borrow overnight in the market for repurchase agreements, where lenders such as money market funds grant short-term loans to bond brokers, often using government bonds as collateral. The alternatives in the UK, the Reformed Sterling Overnight Index Average (SONIA) and in Europe, the Euro Short-Term Rate (ESTER) are unsecured rates. The Swiss average rate (SARON), a rate secured overnight, is based on a mixture of transaction and survey data.
Possible alternatives to the various LIBOR rates are:
|LIBOR rate||Proposed alternative benchmark|
|EUR LIBOR||Euro short-term rate (ESTER)|
|USD LIBOR||Secured overnight financing rate (SOFR)|
|GBP LIBOR||Reformed Sterling overnight index average (SONIA)|
|CHF LIBOR||Swiss average rate overnight (SARON)|
|JPY LIBOR||Tokyo overnight average rate (TONAR)|
Companies that price intra-group financing transactions or have financing structures (e.g. in-house banks, cash pools and back-to-back loan agreements) based on LIBOR must switch to an alternative interest rate from 1.1.2022 at the latest.
There is still some time until the end of 2021, but the impact on a transfer pricing policy of discontinuing LIBOR requires careful analysis and planning of adjustments. In order to ensure a smooth transition, it is advisable to identify the transactions and structures concerned in good time and to develop transition scenarios in order to counter the abolition of LIBOR appropriately.
As a part of increasing international tension on trade flows recently, Foreign exchange (“FX”) positions became more volatile. As a result, FX management which has always been an integral element in transfer pricing, has become increasingly more important, as it plays a part in determining arm’s length remuneration for an intercompany transaction. Further, in the post BEPS world and also considering the OECD BEPS actions 8-10 financial-transactions discussion draft, 2018, the measures that have been taken to mitigate the FX risk are also now under scrutiny like never before. In this regard, some of the issues that we have come across in respect of FX management that require an examination to be made by treasury teams of an MNE are listed below:
When setting up a transfer pricing policy, keep in mind the following three important points:
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