January 11, 2023 - Picking up where we left off last week, we now take a look at what the final rule of the LIBOR Act (“Final Rule”) means for syndicated loans, bilateral loans, and CLOs governed by U.S. state law. Below is a high- level look at the provisions of the final rule that are most salient for our members and is not an exhaustive summary.
Where a contract has insufficient or non-existent fallback language…
After ignoring any requirement in the contract to conduct a poll or inquiry for quotes to determine the replacement rate, non-consumer cash products, like business loans and CLOs, that i) do not provide a non- LIBOR based replacement rate, and (ii) do not identify a “determining person” who can select a replacement rate, will transition to CME’s Term SOFR plus the ARRC/ISDA spread adjustments, in each case for the corresponding tenor replacing USD LIBOR (“Adjusted Term SOFR”). Subject to the same conditions, the final rule provides for derivatives to transition to SOFR compounded in arrears plus the ARRC spread adjustments, in each case for the corresponding tenor. The difference in rates ensures that derivatives transition via the Final Rule land in the same place as derivatives subject to the ISDA protocol, but parties must mind the gap when looking at hedged cash instruments.
- Syndicated Loans: Loans that include an ultimate fallback to a non-LIBOR based rate, e.g., Prime or the Fed Funds Rate, are unaffected by Final Rule. The presence of an ABR rate in credit agreements for syndicated loans is widespread so few (if any) syndicated loans are expected to be affected by the LIBOR Act.
- Bilateral Loans: Where bilateral loans include any non-LIBOR based fallback rate they will be similarly unaffected. The universe of bilateral loans is large and diverse so market participants should confirm whether a fallback rate exists in bilateral loans.
- CLOs: Before language was introduced in indentures to address LIBOR replacement, the customary fallback in CLO indentures was to the last published LIBOR. Such a fallback is a classic example of one the LIBOR Act was designed and does address. Such CLO indentures will automatically transition to Adjusted Term SOFR on the LIBOR replacement date, i.e., the first London banking day after June 30, 2023. This occurs by operation of law pursuant to the Final Rule.
Where a contract has a determining person…
The existence of a determining person for purposes of a contract under the Final Rule creates two paths to transition for those contracts. Assuming the terms of a cash product do not automatically transition to Adjusted Term SOFR pursuant to the Final Rule for the reasons stated above, the terms of a cash product may identify a person (a “determining person”) that has the authority, right or obligation to determine a benchmark replacement. Where such a person exists, the Final Rule will not override the terms of that contract unless the person fails to make a selection by June 30, 2023. If a determining person fails to act by that time (or by the date specified in the contract if earlier), the contract will automatically transition to Adjusted Term SOFR on the LIBOR replacement date by operation of law. The LIBOR Act further provides safe harbor protection for determining persons (i.e., persons authorized under the terms of the contract) who select the replacement rate for the relevant product as set forth in the Final Rule. For instance, the safe harbor protection would be available to a determining person in a credit agreement that selects Adjusted Term SOFR as the replacement rate.
Given the importance of whether there is a determining person in a contract for purposes of the Final Rule, commenters on the proposed rule requested certain clarifications. Of particular note, the “determining person” definition in the Final Rule clarifies that the person must have sole authority to make the selection under the contract and a person meets the definition even if its authority under the contract is contingent on any event or circumstance.
- Syndicated Loans: It is expected that few (if any) syndicated loans have a “determining person” for purposes of the Final Rule. The final rule makes clear that collective action to select a replacement rate, e.g., a borrower and administrative agent selecting a replacement, does not rise to the level of a “determining person”.
- Bilateral Loans: It is expected that many bilateral loans may provide for a “determining person”, such as where a replacement rate is selected by the lender and the credit agreement does not include a non-LIBOR replacement rate. A “determining person” includes a party with the ability to select a rate only if LIBOR is unavailable in the relevant contract.
- CLOs: It is not expected that there is a “determining person” in many CLO indentures. A party needs to have the ability to select (read: choose) a replacement rate. A party that merely has the role of determining that Term SOFR exists, for instance, would not be a “determining person.”
Synthetic USD LIBOR
The final rule’s adopting release explicitly addresses the interplay of synthetic USD LIBOR (the future existence of which has not been confirmed) and the LIBOR Act as implemented. Contracts transitioned pursuant to the Final Rule would not use synthetic LIBOR. The final rule also does not purport to clarify the term “availability” to include “availability on a representative basis” where those words are not included in the contract. The LSTA advocated for the approach taken in the final rule, namely contract terms that provide for the continued use of LIBOR if available/ascertainable – which synthetic USD LIBOR would be until it ceased – are unaffected. The alternative approach would have forced certain loans to fallback to Prime, for example, after June 30, 2023 even if the credit agreement would technically allow for synthetic USD LIBOR to be used. It is important that market participants are aware, however, that any synthetic USD LIBOR will be subject to a statement by the FCA that the rate is not representative. Contracts with ARRC fallback language (of any flavor) is one category that would not use synthetic USD LIBOR for this reason. Contracts that have LIBOR non-representativeness language (directly or by implication – check your document!) also would not use synthetic USD LIBOR.
The Final Rule specifies conforming changes which would apply to contracts transitioned by its terms. Those changes are important to properly administer the rate. The Federal Reserve may specify additional conforming changes in the future. The final rule also gives a “calculating person” in a non-consumer contract the ability to make reasonable technical, administrative or operational changes to permit proper administration or calculation of the replacement rate if the contract is transitioned pursuant to the final rule. The final rule becomes effective 30 days after its publication in the Federal Register which has not yet occurred. The LSTA will continue to educate members on developments relating to these topics. In addition, a video on this topic will soon be available.