November 23, 2022 - The UK’s Financial Conduct Authority (FCA) has now made clear its intentions with respect to synthetic USD LIBOR and – subject to its market consultation – synthetic versions of 1-, 3-, and 6-month USD LIBOR would be available through September 2024. Thereafter, publication of these USD LIBOR settings would cease permanently. In addition, the FCA announced that it would compel the publication of 3-month synthetic Sterling LIBOR until end-March 2024 after which it would cease permanently.
These announcements represent the final missing pieces to the LIBOR transition puzzle. The publication of synthetic USD LIBOR will have implications for certain legacy LIBOR loans, but the main message of the FCA and the ARRC is that market participants should continue to wind down their existing LIBOR exposures ahead of June 2023 and the temporary availability of synthetic LIBOR settings should not slow transition plans. To that end, the ARRC has published its Legacy Playbook which outlines frameworks to support the transition of legacy LIBOR cash products by mid-2023. Below we set out the key points in the consultation as well as the implications for legacy LIBOR loans.
FCA Consultation
On November 23, 2022 the FCA released its much anticipated consultation on synthetic USD LIBOR and will be accepting comments until January 6, 2023. The consultation principally solicits feedback on the FCA’s proposal, the methodology for synthetic USD LIBOR settings, and what use of these settings should be allowed. Because of the volume of legacy contracts that reference USD LIBOR, a great many of which exist outside of the US, the FCA believes it is appropriate to require:
- The publication of 1‑, 3‑ and 6‑month synthetic US dollar LIBOR settings until end‑September 2024;
- the methodology for each setting would be the relevant tenor of CME Term SOFR plus the relevant ISDA fixed spread adjustment, i.e. the same formulation used in ARRC fallback language;
- these synthetic US dollar LIBOR settings would be permitted to be used in all US and non-US legacy contracts except cleared derivatives
The FCA’s announcement of a synthetic USD LIBOR is intended to provide a temporary, unrepresentative solution for non-US tough legacy contracts referencing US dollar LIBOR. The 15-month publication of the three synthetic USD LIBOR settings could, however, provide relief for certain legacy loans (described below). Given the enactment of the LIBOR Act together with the prevalence of ARRC recommended fallback language in legacy LIBOR contracts, the end of June 2023 – the date after which USD LIBOR is no longer representative – will remain the key transition date. Following the announcement, the ARRC reminded market participants of this fact, noting “that the announcement does not change the ARRC’s recommendations for market participants to prepare for a transition ahead of the June 2023 transition date, when LIBOR will become non-representative, triggering ARRC-recommended fallbacks, and when the LIBOR Act will go into effect.”
The FCA will publish its final decision and any necessary announcements connected to it after reviewing the feedback received.
What does this mean for legacy loans?
The FCA’s decision to compel the publication of synthetic USD LIBOR on a temporary, non-representative basis is not expected to affect many US contracts. First, the LIBOR Act goes into effect upon the FCA declaring LIBOR to no longer be representative. This would mean that LIBOR contracts that are in-scope for purposes of the LIBOR Act will transition to the relevant SOFR + ISDA/ARRC adjustment after June 30, 2023. Aside from loans, many cash products either have unworkable fallback language or ARRC recommended fallback language (which also is triggered upon USD LIBOR being declared to no longer be representative) so these contracts will transition after June 2023. Uniquely, there is two group of legacy USD LIBOR loans that would be impacted by today’s FCA announcement. First are loans (typically originated pre-/early 2018) neither have workable fallback language nor meet the requirements to be in scope for the LIBOR Act. These loans typically have a fallback to Prime. For these loans, the publication of synthetic USD LIBOR will delay the loans from falling back to Prime at transition. Instead, the loans would reference synthetic LIBOR – a result which is fully aligned with ARRC fallback language, i.e. Term SOFR plus the relevant ISDA/ARRC adjustment. Borrowers will benefit from avoiding the high costs associated with Prime and Agents and Lenders will benefit from the operational ease of continuing to look to the same LIBOR screen after June 2023. In addition, some loans with LIBOR fallback language do not include a “non-representativeness” clause and might also use synthetic UDS LIBOR. It is important to note, however, that the regulations proposed by the Federal Reserve this summer had asked whether this should be the result or whether loans that could look to synthetic LIBOR by the terms of the credit agreement should nevertheless be prevented from doing so. The LSTA submitted comments on that proposal requesting the Federal Reserve take no such action. Final rulemaking was expected on September 11th but has not yet been released. Perhaps after today’s FCA statement, the final rulemaking will be quick to follow!
