January 5, 2023 - On December 16th the Federal Reserve (the “Board”) adopted its final rule implementing the Adjustable Interest Rate (LIBOR) Act (“Act”). This rule has been long awaited since first proposed last summer and provides the key details on how the Act will apply to in-scope contracts. As previously reported, it is expected that the Act will not significantly impact U.S. syndicated loans, but it will have a more significant impact on certain legacy bilateral loans and CLOs in the U.S. (in addition to many other U.S. contracts referencing Libor). We are gratified to see that many of the LSTA’s comments on the proposal are reflected in the final rule. Below we look briefly at the elements of the final rule and next week we will tackle specific implications for syndicated loans, bilateral loans and CLOs.
The final rule identifies three categories of LIBOR contracts governed by U.S. law as described in Cadwalader’s recent memo:
- Contracts which include fallback language that identify a specific, non-LIBOR based benchmark replacement and do not require the conducting of a poll for quotes to determine the benchmark replacement;
- General expectation: transition to the benchmark replacement identified in those contracts will occur on or before the LIBOR replacement date (i.e., the first London banking day after June 30, 2023).
- Contracts that (i) contain no fallback language and (ii) do not identify a determining person (i.e., a sole person who can select a LIBOR replacement) and that only (A) identify a benchmark replacement that is based on LIBOR or (B) require the conducting of a poll for quotes to determine the replacement rate;
- General expectation: transition to the Board-selected benchmark replacement (as provided in the final rule for that particular instrument) on the LIBOR replacement date.
- Contracts that contain fallback provisions authorizing a determining person to determine a benchmark replacement.
- General expectation: transition to the benchmark replacement selected by the determining person, or to the Board-selected benchmark replacement if no benchmark replacement is selected by the determining person by the LIBOR replacement date.
In sum, the first category of contracts, which includes loans falling back to Prime or Federal Funds Rate, are governed by the terms of those contracts. For affected contracts (i.e., the second category and third category where the determining person does not make a selection), the final rule provides the benchmark replacement that will apply to a contract (based on the type of instrument), the applicable spread adjustment(s), and specific conforming changes designed to properly administer the benchmark replacement. These terms are “written in” to those contracts by operation of law. (And parties cannot ignore the law.)
The Act and the final rule provide important protections. For non-consumer contracts, a calculating person is empowered to make additional conforming changes necessary to implement the benchmark replacement. In addition, a determining person who selects the Board-selected benchmark replacement benefits from a safe harbor.
A further discussion of the final rule can be found in memos by Sidley and Mayer Brown. Next week we will cover clarifications in the final rule, the implications for syndicated loans, bilateral loans and CLOs, and the interplay of synthetic USD LIBOR. (We previously covered synthetic USD LIBOR here and here.)
Please take note that we are preparing additional educational materials and welcome specific questions from members which should be sent to LIBORinformation@lsta.org.