September 6, 2022 - Last week, the LSTA submitted a comment letter responding to the Federal Reserve’s (“Fed”) Notice of Proposed Rulemaking (“NPR”) on the implementation of the LIBOR Act (“Act”). Below we discuss the LIBOR Act, the NPR and, in particular, why the LSTA felt compelled to comment. Note: We covered the LIBOR Act and the NPR themselves in more detail in a previous article and recent webcast with Cadwalader.
The LIBOR Act was intended to help “tough legacy contracts” – those lacking workable fallback language – transition to a replacement rate when LIBOR ceases. 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 the Fed’s NPR potentially brings some loans back into scope of the legislation. Here’s how.
The NPR and Synthetic LIBOR: The Act required the Fed to promulgate Rules to implement the Act, theoretically by Sept 11th. But several intersecting issues in the NPR may have unintentional consequences for loans. First, 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 chances are that synthetic USD LIBOR would be Term SOFR + ARRC Spread Adjustment). If the FCA did compel the publication of synthetic LIBOR, those loan contracts without a “non-representativeness” trigger might continue to simply look at LIBOR pages on Bloomberg or Reuters and thus use synthetic LIBOR. As an example, a pre-2018 loan that does not have specific LIBOR transition language but does have an option to borrow on Prime if LIBOR is unavailable would potentially use synthetic LIBOR (until it ceases) in this situation. In contrast, a loan that uses ARRC fallback language (which includes a non-representativeness clause) would transition to its replacement rate.
The Fed noted that the potential existence of synthetic LIBOR could create ambiguity. They asked whether they should specify that the contractual replacement mechanism take effect on the LIBOR replacement date. (In the example of the pre-2018 loan, it would transition to Prime.) The LSTA’s recommendation was that the Final Rule should not address this potential ambiguity in the manner suggested in the Proposed Rule, because it would potentially pull contracts that are intentionally not subject to the Act back into scope with unintended consequences.
The NPR and Covered Contracts: The LIBOR Act intentionally covers some contracts and does not cover others, depending on the existence of a fallback or a determining person to execute transition. The NPR takes this further and creates the concept of a “Covered Contract” and a “Non-covered Contract”. While well intentioned, this division of contracts may not work well in practice and at times does not comport with what the LIBOR Act means to do. As an example, the LIBOR Act provides protections for a determining person that selects the Board-selected replacement rate (i.e., Term SOFR + ARRC Spread Adjustment) prior to the LIBOR replacement rate. Under the NPR, this would be a non-covered contract and therefore would not benefit from the Act’s protections. Ultimately, the LSTA’s position is that the division of the world into Covered and Non-covered contracts is unnecessary, confusing and potentially counterproductive. We recommended that these categories be deleted from the final rule.
Clean-up Items: In addition, there were several smaller issues such as the treatment of polling for Eurodollar contracts (we encouraged the Fed to ensure that parties do not have to poll for non-existent Eurodollars), clarification of the definition of determining person (we encouraged the Fed to define it as one legal entity), whether an entity can qualify as a determining person if its authority is contingent on a future event (we argue they should) and whether the Fed should determine specific notice requirements (we argue they shouldn’t). The Final Word: The Fed’s NPR is a critical step in ensuring that the LIBOR Act works as intended for tough legacy contracts. Unlike most proposed rules, this is one that industry desperately wanted. We will soon see how the final rule shakes out.
