A series of important events in March have signaled the definitive end of LIBOR and will provide more economic certainty to market participants and minimize the market impact of transition. They also provide a reminder to, and increase pressure on, market participants to actively transition their financial instruments and commercial agreements that reference LIBOR to risk-free rates.
IBA and FCA Announce Dates for LIBOR Cessation
On March 5, 2021, ICE Benchmark Administration Limited (IBA), the administrator for LIBOR, an-nounced that it will permanently cease to publish LIBOR immediately after the following dates (the Cessation Dates):
- December 31, 2021 for all EUR LIBOR, CHF LIBOR, JPY LIBOR, GPB LIBOR settings and the one- week and two-month USD LIBOR settings; and
- June 30, 2023 for the overnight, one-month, three-month, six-month and twelve-month USD LIBOR settings.
The UK’s Financial Conduct Authority (FCA), IBA’s regulator, promptly confirmed the IBA’s feedback statement in its own separate announcement on the same date. The FCA also indicated that it will consult with the IBA regarding the continued publication of the following “synthetic” and non-representative versions of the:
- one-month, three-month and six-month GPB LIBOR settings for a “further period”;
- one-month, three-month and six-month JPY LIBOR settings for one additional year; and
- one-month, three-month and six-month USD LIBOR settings for a “further period.”
Any such synthetic LIBOR settings would be intended for use primarily to allow legacy LIBOR transactions utilizing these currencies to mature. The FCA announcement made clear that these synthetic LIBOR settings will “no longer be representative of the underlying market and economic reality” after the respective Cessation Dates and included an express acknowledgement that fallback provisions contained in contracts that reference the affected LIBOR settings would be triggered, as further detailed below.
Loan Agreements Incorporating ARRC Fallback Terms
For loan agreements that incorporate the Alternative Reference Rates Committee (ARRC) fallback terms (ARRC Fallback Terms), the ARRC has confirmed that the announcements by the IBA and FCA constitute a “Benchmark Transition Event” for all USD LIBOR settings. This signals the com- mencement of the replacement process but does not, however, trigger an immediate transition to the replacement rate. In particular, the effect of the announcements depends on whether the applicable loan agreements have adopted the “hardwired” approach or the “amendment” approach. In the case of both approaches, the IBA and FCA announcements may trigger a requirement that agents notify borrowers of the occurrence of a trigger event, but no change would actually occur until the parties agree to amend the loan agreements. Under the hardwired approach, while there may be notice requirements by an agent/sole lender related to the occurrence of the Benchmark Transition Event under the loan agreement, the occurrence of a Benchmark Transition Event does not require an immediate transition under (ARRC) Fallback Terms. Instead, the transition to (SOFR) will automatically occur upon the Cessation Dates of the relevant LIBOR settings. Under the amendment approach, the Benchmark Transition Event trigger may require notice of the event by an agent/sole lender and would allow for the amendment process to begin. However, such an amendment could not take effect until the 90-day window (or the number of days to which parties have agreed) commencing on April 1, 2023. It should be noted that, under either approach, the loan agreements may include “early opt in” terms that would permit the agents and the borrowers to elect an earlier transition. In any case, the credit spread adjustment for each relevant LIBOR setting will be the credit spread adjustment as calculated on March 5, 2021, and published on Bloomberg.1
Derivatives Incorporating ISDA Fallback Terms.
Following the FCA announcement, the International Swaps and Derivatives Association (ISDA) stated that the announcement constitutes an “Index Cessation Event” under the ISDA 2020 IBOR Fallbacks Protocol and Supplement (ISDA Fallback Terms), which in turn triggers a “Spread Adjustment Fixing Date” under the Bloomberg IBOR Fallback Rate Adjustments Rule Book for all LIBOR settings on March 5, 2021. An Index Cessation Event does not mean that the new fallback rates will immediately apply to derivatives transactions that incorporate ISDA Fallback Terms, but rather, the fallback rates will begin to apply on the applicable “Index Cessation Effective Dates,” which are:
- the first London Banking Day on or after January 1, 2022 for all EUR LIBOR, CHF LIBOR, JPY LIBOR, GPB LIBOR settings and the one-week and two-month USD LIBOR settings; and
- the first London Banking Day on or after July 1, 2023 for the overnight, one-month, three-month, six-month and twelve-month USD LIBOR settings.
Note that the Index Cessation Effective Date for the one-week and two-month settings of USD LIBOR is different than the date on which such settings will permanently cease to be published (i.e., January 1, 2022). For these two settings only, linear interpolation based on the longer and shorter tenors (which will continue to be published before July 1, 2023) will be used to determine those settings from January 1, 2022 through June 30, 2023. Once linear interpolation is no longer possible for those settings (i.e., commencing on July 1, 2023), an Index Cessation Effective Date will be deemed to have occurred with respect to those settings.
It should also be noted that loan agreements that incorporate the ARRC Fallback Terms do not pro- vide for such linear interpolation for the one-week and two-month USD LIBOR settings for the period beginning January 1, 2022 through June 30, 2023; instead, loan agreements that provide one-week or two-month USD LIBOR options only will transition to the new fallback rates (i.e., the “Benchmark Replacement”) immediately after December 31, 2021. As a result, this is an area of potential divergence between these loans and the associated derivatives, as a loan agreement that references one-week or two-month USD LIBOR settings that has transitioned to a Benchmark Replacement may have a rate that is different from the interpolated rate referenced in its associated derivatives until the new fallback rates apply on July 1, 2023.
The IBA announcement can be found here.
The FCA announcement can be found here.
The ISDA announcement can be found here.
New York State Legislature Passes LIBOR Legislation
On March 24, 2021, the State of New York approved legislation that will be crucial in minimizing legal uncertainty and adverse economic impacts associated with LIBOR transition, providing greater certainty to market participants as the financial system continues its move away from LIBOR.
Many financial instruments referencing LIBOR do not envision a permanent or indefinite cessation of LIBOR. Certain “tough legacy” instruments either do not have fallback terms and conditions that adequately address a permanent LIBOR cessation or have terms and conditions that could dramatically alter the economics of contract terms if LIBOR is permanently discontinued. Although existing contracts may be amended, such an amendment process might be challenging, if not impossible, for certain products. Senate Bill 297B/Assembly Bill 164B addresses those legacy contracts that mature after the mid-2023 cessation date of LIBOR that lack effective fallbacks. Because New York law governs many of the financial products and agreements referencing LIBOR, the new legislation will provide legal clarity for these instruments and will reduce the burden on New York courts, as legal uncertainty surrounding the transition likely would have prompted disputes.
The impact on loan agreements is minimal – the key benefit being the elimination of any bank polling requirement that might apply if LIBOR is unavailable. However, for loan agreements where the borrow- er has an option to elect one-week or two-month USD LIBOR, the legislation clarifies that LIBOR for purposes of that agreement is unaffected and the remaining interest elections would continue to be available through June 2023.
Notably, the legislation will:
- prohibit a party from refusing to perform its contractual obligations or declaring a breach of con- tract as a result of LIBOR discontinuance or the use of the legislation’s recommended benchmark replacement;
- establish that the recommended benchmark replacement is a commercially reasonable substitute for and a commercially substantial equivalent to LIBOR; and
- provide a safe harbor from litigation for the use of the recommended benchmark replacement.
Importantly, however, the legislation will not override existing contract language that specifies a non-LIBOR based rate as a fallback to LIBOR (e.g., the Prime rate).
As noted above, the issue of tough legacy contracts is one facing, and being tackled, by many LIBOR currency jurisdictions. The European Com- mission recently adopted amendments to the Benchmark Regulation to implement its legislative solution which are now effective. Furthermore, the FCA will be consulting on its proposed expanded powers under the Benchmark Regulation this quarter – which LIBOR currency settings may continue on a synthetic, non-representative basis and for which contracts use of those rates would be permitted is of keen interest.
Senate Bill S297 can be found here.