July 5, 2023 - June 30th saw the final publication of panel USD LIBOR rates. It seems the loan market has successfully completed its last phase of LIBOR transition.
Overnight and twelve-month USD LIBOR rates have ceased permanently. One-month, three-month, and six-month rates have also ceased as representative panel rates, but they will continue on a non-representative, synthetic basis for fifteen months. The Financial Conduct Authority (FCA)’s decision to compel IBA to publish these synthetic rates for a period of time was subject to market consultation and highly telegraphed. So on July 1st, with little fanfare, the FCA published its Article 23D notice directing IBA to publish the three rates based on a non-representative, synthetic methodology of the relevant tenor of CME’s Term SOFR plus ISDA/ARRC adjustment and its Article 23C notice restricting use of the synthetic rates to most legacy contracts. In summarizing these steps in its July 3rd statement, the FCA stated that “these settings are now permanently unrepresentative” and reiterating that these setting could not be used in new contracts.
Many LIBOR loans already transitioned to a replacement rate far in advance of actual cessation, as a result of consensual amendments, early opt-in triggers or usage of the standard 90-day window for amendments. However, the FCA’s announcement that USD LIBOR is no longer representative served as a trigger event for ARRC-standard hardwired fallback language meaning that Term SOFR plus the applicable standard ARRC/ISDA spread adjustment has contractually replaced LIBOR as the applicable benchmark in approximately 35% of LIBOR loans in the CS LLI. Moreover, outstanding LIBOR loans with ARRC-standard amendment approach fallback language with benchmark unavailability provisions now reference ABR, Base Rate, Prime or another similar “failsafe fallback” unless they have been amended to replace LIBOR. Note that exact timing for fallbacks will depend on the applicable lookback period and mechanics of a given loan. Given the quarter-end timing of the FCA announcement, we expect that many legacy credit agreements will only have their first SOFR (or Prime) rate setting at the next interest reset – whether it be end of July or later depending on the relevant borrower’s interest election. Therefore, the migration to SOFR will continue through the summer and indeed until the end of the year for some loans. Looking ahead, legacy loans that now reference the synthetic LIBOR rates will need to continue with active transition plans ahead of the end-September 2024 deadline.
In other benchmark news, on the heels of panel USD LIBOR ending, IOSCO published its much anticipated “Review of Alternatives to USD Libor” assessing how four potential substitutes for USD LIBOR have implemented the International Organization of Securities Commissions (IOSCO) Principles for Financial Benchmarks. Of particular interest to the loan market is IOSCO’s findings on the two Term SOFR rates – CME’s Term SOFR and IBA’s Term SOFR – the former being the most ubiquitous successor to LIBOR in corporate lending. As directly compared to SOFR, IOSCO found that the Term SOFR rates were “better placed among the rates reviewed, but still fell short of SOFR”. This is not unexpected given the depth of underlying transactions underpinning SOFR – a daily average of roughly $1 trillion in transaction volume. The IOSCO Report highlighted the need for the use of Term SOFR to remain limited, particularly in derivatives markets. Again, these finding are not surprising and are consistent with the ARRC’s recommendations on the use of Term SOFR. Last updated in April, the ARRC recommendations clearly contemplate the use of Term SOFR in business lending, securitizations of business loans, and related derivatives activity to be onsides. Aside from Term SOFR rates, the IOSCO Review did have some harsh words on the two credit sensitive rates (CSRs) reviewed, Ameribor and BSBY. IOSCO’s work confirmed regulatory authorities’ concerns that CSRs exhibit some of the same inherent “inverted pyramid” weaknesses as LIBOR and that their use may threaten market integrity and financial stability. IOSCO further recommends that benchmark administrators, auditors and independent consultants refrain from any representation that the CSRs reviewed are “IOSCO-compliant.” It will be interesting to see how such parties choose to address (or not address) outstanding IOSCO Compliance Statements. Nothing in the IOSCO Review can prevent CSRs from continuing to be offered, but certainly market participants will need to digest this latest recommendation. Furthermore, where members have adopted CSRs in loans, they should be aware of the fallback language in those loans and look out for whether IOSCO compliance of the relevant CSR has any implications for those credit agreements.
