August 24, 2022 - The Adjustable Interest Rate (LIBOR) Act (“the Act”) was passed earlier this year to help “tough legacy contracts” transition to a replacement rate at LIBOR cessation. “Tough legacy contracts” are those that lack workable fallback language and have no effective means to transition. Most large corporate business loans were out of scope of the legislation – and intentionally so, because even those that did not have explicit LIBOR fallback language generally did have the ability to use to ABR/Prime if LIBOR was not available. But – and this is a big but – the Federal Reserve’s Proposed Rulemaking (“NPR”) released in July potentially brings some loans back into scope of the legislation. This issue, which was the topic of an LSTA LIBOR Legislation/NPR webcast featuring Cadwalader’s Lary Stromfeld and Jeff Nagle and LSTA’s Meredith Coffey and Tess Virmani, could lead to unexpected interest rate outcomes for parties in loan contracts. We recap the issues below and encourage interested persons to access the LSTA webcast replay and slides.
The Legislation: The LIBOR Act imposes a statutory replacement rate on contracts i) with no fallback provisions and ii) those that do not identify a specific non-LIBOR fallback and do not have a person to determine the rate (“determining person”). Contracts that have fallbacks, have a determining person or fallback to a rate such as Prime are not within the scope of the legislation. Importantly, the Act provides certain protections arising out of the transition from LIBOR, including around the selection, use and implementation of the statutory replacement rate. The legislation also required the Fed to promulgate rules within 180 days (approximately Sept. 11, 2022) to implement the Act.
The NPR: The Act requires the Federal Reserve Board (“Fed”) to select the SOFR-based replacement rate (the Fed selected Term SOFR + ARRC Spread Adjustment for business loans, the same as the ARRC hardwired fallbacks) and requires the Fed to identify conforming changes (which the Fed declined to do). In addition, the Fed also divided contracts into “Covered” contracts (those to which the Act automatically applies the statutory replacement) and “Non-Covered” contracts (all the other contracts). Dividing the world thusly has significant implications.
Synthetic LIBOR: A wildcard in this mix is that the UK’s Financial Conduct Authority (“FCA”) is consulting on whether to compel the ICE Benchmark Administration (“IBA”) to publish a synthetic USD LIBOR for a period of time once USD LIBOR ceases as a panel rate after June 2023. Doing so would give non-US law governed USD LIBOR contracts without workable fallbacks more time to remediate. The FCA took this tack for GBP LIBOR and Yen LIBOR and used the construct of Term RFR + ISDA Spread Adjustment; the corollary USD rate would be Term SOFR + ARRC Spread Adjustment – again, the same as the Hardwired Fallback.
What all this might mean for corporate loans: First, the division of the world into “Covered” and “Non-Covered” contracts means that some contracts may not benefit from some of the protections in the LIBOR Act. Second, some contracts that arguably are not in scope of the LIBOR Act could theoretically come back into scope depending on how the Fed Rule is finalized. This becomes particularly interesting if synthetic LIBOR is published. In effect, if the FCA compels the IBA to publish synthetic LIBOR, it will also simultaneously state that synthetic LIBOR is non-representative. This would mean that any contract that has a “non-representativeness” LIBOR fallback trigger would be triggered and would transition to its replacement rate. Both the ARRC Amendment and Hardwired Loan Fallbacks have a non-representativeness trigger and therefore would transition. However, absent a Fed rule, a loan contract that did not have a non-representativeness trigger and continued looking to the applicable LIBOR page may well use synthetic LIBOR until that rate ceased and then would transition to its replacement rate (such as Prime for loans with no specific fallback rate). The Fed is concerned that the existence of synthetic LIBOR could lead to potential ambiguity for LIBOR contracts that are only triggered when LIBOR is unavailable but not triggered when LIBOR is available but non-representative. Thus, the Fed is considering specifying in the final rule that for non-covered contracts, the contractual replacement will be triggered on the LIBOR replacement date (e.g., June 30, 2023) if not before, regardless of whether the loan has a non-representativeness trigger. (The webcast reviews a host of examples – the variability of potential outcomes may surprise parties!)
Bottom Line & Next Steps: The intersection of the LIBOR Act, the Fed’s NPR and the potential existence of synthetic LIBOR could complicate transition for large corporate loans. The LSTA has been working to draft a comment letter – due August 29th! – reflecting member views.