March 25, 2021 - updated on July 12, 2021. New York State Legislature has now passed the legislation (Senate Bill 297B/Assembly Bill 164B), proposed by the ARRC and sponsored by New York Senator Kevin Thomas, which is designed to solve transition issues for certain legacy products that have insufficient fallback language. While the bill still awaits Governor Cuomo’s signature, this is a major milestone in the transition process for legacy products, and one which was welcomed by the ARRC. As previously reported, because of the relative flexibility of loans and the ultimate fallback to Prime in most legacy credit agreements the legislation’s touch points to the loan market, by design, are few but the legislation would capture pre-2H 2017 CLO indentures – to the extent they are outstanding after end-June 2023.
Why is the legislation needed?
The issue of tough legacy contracts – those who have nonexistent or impractical fallback language with little means to address that – is one facing, and being tackled, all the LIBOR currency jurisdictions. For the US, one critical piece is the recent extension of many USD tenors to mid-2023 which permits many of these tough legacy contracts to roll off. However, as the ARRC points out, there will still be a significant portion of contracts that would mature after that date, including those that have no effective means to replace LIBOR upon its cessation. The legislation addresses those contracts without effective fallbacks that are written under New York law and provides the blueprint for pending federal legislation efforts.
What does it mean for CLOs?
CLO indentures which are silent on rates or fallback to a LIBOR-based fallback rate (e.g. last print of LIBOR) are in-scope for the legislation. These pre-2H17 CLOs, however, are not expected to be many by the time 3M USD LIBOR ends. Nomura recently estimated $54 billion of these CLOs are outstanding today and further estimates just $31 billion will be outstanding after June 2023 – as nearly all of the pre-2H17 CLOs are likely to have been called, refinanced or reset by then. For the stub universe of these CLOs, the legislation would essentially write in ARRC fallback language into the indentures. The legislation would see, after June 2023, those CLOs fallback to a SOFR-based rate (including any spread adjustment and conforming changes) recommended by the “relevant recommending body”, i.e. the Federal Reserve Board, the FRBNY or the ARRC. A result expected to align with the ARRC fallback language itself.
What does it mean for Loans?
As noted above, the impact on loans is expected to be limited- the key benefit being the elimination of any bank polling requirement if LIBOR is unavailable that might be present in a credit agreement. Otherwise, most loans will be outside the scope of the other aspects of the legislation because they contain fallback provisions, such as the ABR, that result in a non-LIBOR based replacement rate. For credit agreements that are within scope of the legislation where the borrower has the option to elect 1-week or 2-month USD LIBOR – which will cease after 2021 – the legislation would not move the contract to the statutory replacement benchmark so long as the borrower has the option to choose other tenors or the contract requires the discontinued tenors to be interpolated. Notably, the legislation does not impose an obligation to interpolate that does not exist under the contract.
As noted above, this legislative solution is limited to New York-law governed contracts (the predominant governing law for financial contracts in the US), but efforts are being made for similar legislation at the federal level. Congressman Brad Sherman is leading Congress’s work on a draft version of federal legislation that would largely mirror the New York State legislation. That will continue to be a space to watch. Looking at other LIBOR currency jurisdictions, the European Commission recently adopted amendments to the Benchmark Regulation to implement its legislative solution which are now effective. Furthermore, the UK 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. Those answers are expected later this year.