April 3, 2023 - Today, the UK Financial Conduct Authority (“FCA”) announced that it would compel the Ice Benchmark Administration (“IBA”) to publish an unrepresentative “synthetic USD LIBOR” through September 30, 2024, for use in legacy contracts with no ability to fallback. Below we unpack the announcement, but the bottom line is that this is exactly what we expected to occur and have been signaling for months; it is business as usual.
What is synthetic USD LIBOR? Synthetic USD LIBOR will be CME Term SOFR plus the ISDA/ARRC Spread Adjustments of 11 bps for 1M, 26 bps for 3M and 43 bps for 6M. This means it is the same rate that will be used in loans with ARRC hardwired fallbacks as well as contracts that transition through the US LIBOR Act. This was completely intentional so that contracts would fall back to the same rate and CSA.
Who can use synthetic USD LIBOR? Synthetic USD LIBOR can only be used by legacy contracts with no other means to fall back. It may not be used for new LIBOR contracts. Synthetic USD LIBOR is a solution largely for non-US law governed contracts referencing USD LIBOR that had no means to fall back. (And there are many such contracts, including in developing markets.) By compelling the IBA to publish synthetic USD LIBOR through September 2024, the FCA is attempting to give parties with these (largely) non-US law governed contracts more time to transition actively or for the contracts roll off. US governed agreements with no fallback language typically would be covered by the LIBOR Act (the federal legislation) and thus already would be transitioning to CME Term SOFR plus the ISDA/ARRC Spread Adjustments.
What does this mean for syndicated loans? Most syndicated loans will continue to fall back using their contractual fallback language. (According to Covenant Review, over 90% of the LIBOR loans in the CS Index have intentional and contractual fallback language.) Loans with hardwired fallbacks will transition to CME Term SOFR + ARRC CSA. Loans with amendment fallbacks typically will transition using their amendment process. The places that synthetic USD LIBOR might be used in the US syndicated loan market include (i) loans that have no intentional and contractual LIBOR fallback language and otherwise would go to Prime and (ii) loans with amendment fallback language that have no direct or indirect “non-representativeness” transition triggers. Members are encouraged to review their agreements to determine whether the availability of synthetic USD LIBOR impacts those agreements once USD LIBOR is no longer representative (i.e., after June 30th). For a discussion on the potential impact of synthetic USD LIBOR, watch this video.
Why do direct or indirect “non-representativeness” transition triggers matter? The FCA is compelling the IBA to publish an “unrepresentative” synthetic USD LIBOR; by that they mean that synthetic LIBOR is not representative of an interbank lending market. Loans with ARRC hardwired or amendment fallback language typically will transition when LIBOR either ceases or is no longer representative; thus, these loans cannot use synthetic USD LIBOR. A number of loans with non-ARRC amendment fallback language also have a non-representativeness trigger. These are all examples of “direct” non-representativeness triggers. But a number of loans also have an “indirect” non-representativeness trigger in that the relevant definition of “LIBOR” may reference, for example, the market for interbank deposits. Since that is not what synthetic LIBOR is, these loans likely will not look to synthetic USD LIBOR. However, there are some loans that may define LIBOR simply as the “London Interbank Offered Rate” available on a certain screen on Bloomberg or Refinitiv. USD LIBOR still will be published on these pages – albeit in a non-representative form – so if a contract simply points to a page, these contracts likely will reference USD synthetic LIBOR (but only through September 30, 2024).
The bottom line(s): The FCA news should surprise no one who has been following the issue; it was exactly what they were signaling. It is important for loan market parties to know the language in their credit agreements to determine whether and how the publication of synthetic USD LIBOR impacts those agreements. And, finally, nearly all loans with fallback language have the ability to transition early. The easiest way to remove uncertainty around fallbacks is to transition now.