Over the years, the London Interbank Offered Rate of Exchange (LIBOR) has been the most frequently used benchmark for short-term interest rates, affecting trillions of dollars in financial products of different currencies with maturities ranging to over 15 years around the world.
The LIBOR is a basic rate of interest used in lending between banks on the London Inter-bank market and used as a reference for setting the interest rates on other loans.
It is the most used benchmark reference rate in the global financial markets and is calculated in five currencies: the US dollar, Japanese Yen, UK Pound Sterling, Euro and the Swiss Franc.
It is set daily by obtaining estimates of 18 banks globally on the interest rates they would charge for different loan maturities. For over 40 years, LIBOR has been used in different ways and circumstances.
In Zimbabwe, LIBOR is used in pricing employees’ loans for tax purposes.
However, the world has rejected the use of LIBOR. The US dollar LIBOR panel was decommissioned on June 30 2023, and US dollar LIBOR rates are longer considered “representative” of the market.
In Zimbabwe, we use it for setting interest rates on different financial products as well as pricing employees loans for tax purposes.
In 2008, LIBOR’s integrity was called into question after a series of fraudulent activities connected to it.
Its regulator, the Financial Conduct Authority (FCA) confirmed the LIBOR cessation date by announcing that all settings for the five currencies used to issue LIBOR will either cease to be provided by any administrator or no longer be representative after December 2021 and the remaining LIBOR settings for US dollar after June 2023.
The World Bank has in response to this announced its new reference rates, as well as their effective dates, and switched over timelines for existing loans that use LIBOR as a reference rate.
The US dollar LIBOR panel has since embarked on smoothly transitioning from LIBOR to use Forward – looking Term rates such as the Secured Overnight Financing Rate (SOFR) as a replacement rate for LIBOR. Many experts consider the SOFR to be a more accurate and more secure pricing benchmark.
The SOFR is a benchmark that financial institutions use to price loans for business and consumers. The overnight financing part of its name references how SOFR sets rates for lenders; it is based on the rates that large financial institutions pay each other for overnight loans.
The transition from LIBOR to alternative risk-free rates represents one of the biggest changes to the financial services industry. Given that LIBOR ceased to be published as a floating rate benchmark for other currencies at the end of 2021 except for US dollar LIBOR, which continued to be published until June 2023, continued reliance on the LIBOR is a stopgap measure that should soon be revised.
The Reserve Bank of Zimbabwe gave a directive to banks in May 2023 on the need to prepare for the end of use of LIBOR as a reference rate. Further, it encouraged that financial institutions should engage their clients to adopt other reference rates such as the SOFR, which are now being used by most jurisdictions. To enable the transition, the central bank is on record for saying that while LIBOR is no longer being used to price new loans, it will formally stick around until the end of 2023.
The question is, will the central bank employ the Central Counterparties (CCP) as an interim measure? Central counterparties (CCPs) have been instrumental as a global reference in easing the transition away from LIBORs.
The Bank of England issued news announcing the discontinuation of US dollar LIBOR panel rates at the end of June 2023, along with a calendar of planned CCP activities.
All contracts that reference US dollar LIBOR will need to be actively changed to reference robust alternative rates such as the CCP as an interim measure and eventually to SOFR.
The impact on unremedied trades may vary by location and may thus harm clients’ trades if they do not act quickly. This can be accomplished by altering contracts to include a rate switch or by forming whole new and different contracts.
The Zimbabwean Income Tax Act refers to LIBOR in determination of loan benefit arising on interest free loans granted to employees. A loan benefit arises when, because of employment, an interest free loan is granted to an employee by an employer. It provides that the loan benefit on US dollar denominated loans is determined using the formular, “A – B = BENEFIT where A is LIBOR + 5% and B is the interest rate paid on the loan by the employee”.
In conclusion, the transition from LIBOR to SOFR marks a significant shift in the financial landscape. As global markets adapt to this change, it is imperative for legislators to consider updating relevant legislation to ensure a smooth transition and to keep pace with the evolving financial industry.
Where the use of multicurrency remains central to the Zimbabwe economy, a shift to a benchmark which resonates with the current trends such as SOFR, to ensure consistency and fairness in the taxation of financial transactions, is imminent.
Furthermore, other relevant pieces of legislation, such as regulations governing derivatives, securities, and lending practices, should also be evaluated, and revised to align with the use of SOFR. This will help maintain regulatory clarity and prevent any potential legal challenges or loopholes arising from the transition.
Meanwhile Matrix Tax School will be hosting its inaugural Transfer Pricing Indaba Africa from November 8-11, 2023 in Victoria Falls, Radisson Blu Resorts Livingstone Zambia.
● Tapera is the founder of Tax Matrix (Pvt) Ltd and the chief executive of Matrix Tax School. He writes in his personal capacity.