December 9, 2020 - It’s been an eventful LIBOR fortnight, and the LSTA is right there with you. On Monday, November 30th, the ICE Benchmark Administration (“IBA”) announced its upcoming consultation on the end of LIBOR for most rates (likely end of 2021) as well as a potentially different time (June 30, 2023) for most USD LIBOR contracts for legacy products only – a move which was welcomed by its regulator, the FCA. On Friday morning, ISDA, the ARRC, the Fed, the FCA and Linklaters released a helpful webcast (and transcript) deconstructing Monday’s announcements. And on Friday evening, the IBA released its consultation. On Monday, November 7th, the LSTA held a webcast on what these moves meant. Whew.
What Happened? IBA and FCA announced that most tenors of USD LIBOR may be extended until June, 30, 2023 for legacy products only. Simultaneously, US Banking regulators made clear that USD LIBOR originations must end “as soon as practicable” and definitely by December 30, 2021, and that new LIBOR originations prior to that date must have an alternative reference rate or a hardwired fallback.
Why Did It Happen? According to November testimony from Fed Vice Chairman Quarles, it was critical to create some runway to allow “tough legacy contracts” – those that mature after December 2021 and are difficult to amend – to roll off. It also creates time for reasoned and workable legislation to pass to address the “hard tail” that mature after June 2023.
How Does This Change LIBOR Transition Work? Not a lot. All the work to end LIBOR originations continues apace. The work on remediating legacy LIBOR contracts must continue as well, but now there is time to do it in a thoughtful and linear (and un-panicked) manner.
How Does the June 2023 End Date for Legacy LIBOR Affect Loans and CLOs? It could be very helpful for loans if the time is used thoughtfully. If institutional loans refinance three years after origination, then half of outstanding loans could transition into SOFR before LIBOR ceases – considerably reducing remediation pressures. The news is mixed for CLOs inasmuch as they could endure a longer period of “LIBOR-SOFR” basis between their assets and liabilities.
What Are the Implications for the Loan Market? These announcements offer the clearest picture into LIBOR’s endgame and have specific consequences that market participants should bear in mind:
- Extended USD LIBOR would continue as a “representative” panel bank rate through June 2023. The IBA and the FCA made clear that the consultation is a product of discussions with panel banks (and others) and the FCA would not welcome this proposed extension if it were not confident of the tenor-settings’ representativeness. This means that pre-cessation trigger events in fallback language will generally not occur for USD LIBOR before end-June 2023 and fears of “zombie LIBOR” can be calmed.
- Spread adjustments are likely to be set simultaneously across currency-tenor settings in early 2021. The IBA’s consultation covers all five LIBOR currencies and seven tenor settings so the announcement stating the outcome of the consultation is intended to be a prospective announcement made shortly after the consultation closes and address the entire benchmark. Practically, this means that the ARRC and ISDA spread adjustments will be set simultaneously as of the date of that announcement – but only applied at the respective LIBOR end dates. In the case of USD LIBOR, this means nearly 2 ½ years before the adjustments would be applied in fallbacks.
- LIBOR currency-tenor settings will not end at the same time or in the same manner. While always a possibility, knowing that certain settings will end at different dates and likely in different ways is significant for multicurrency facilities. Market participants will need to carefully review the fallback language in these agreements and understand the applicable trigger events and their related effective dates. For instance, it seems likely that the most-used settings of Sterling LIBOR will continue after end-2021 in a synthetic form based on spread adjusted-forward looking term SONIA. In fact, it is possible that the most-used settings of USD LIBOR could continue after end-June 2023 as a synthetic LIBOR rate. Fallback language trigger events matter!
- The ARRC legislative solution is very much still on the table. While the extension of the most-used settings of USD LIBOR is designed to allow contracts to organically run off, there will certainly be contracts without workable fallback language that mature after end-June 2023, i.e. “tough legacy” contracts. The legislative solution will be crucial to deal with this “hard tail” of legacy products.
Bottom line: Keep working! The changes provide an opportunity to succeed, not to delay. Stay in the flow by watching the LSTA’s Monday LIBOR Webcast and joining our regular 3 pm ET Monday LIBOR Q&A calls.