September 4, 2024 - The beginning of the fourth quarter is always a busy time for financial market participants, but Q4 2024 looks to be a particularly eventful season. In addition to a heated presidential election and potential interest rate cuts by the Federal Reserve (not to mention anticipated continued robust deal flow), borrowers and lenders can add to their fall agendas yet another event for markets – the end of synthetic U.S dollar LIBOR. As we previously flagged, 1-, 3- and 6-month synthetic USD LIBOR, which the ICE Benchmark Administration (IBA) has published using a revised methodology since July 1, 2023, will be discontinued at the end of the month.
Members will recall that in April 2023, the U.K.’s Financial Conduct Authority (FCA) announced that it would compel the IBA to publish USD LIBOR on a synthetic basis as a “permanently unrepresentative” rate (i.e., the synthetic rate does not represent what panel LIBOR might be if it had continued to be published). At the time of the FCA’s announcement, the LSTA’s expectation was that synthetic USD LIBOR would primarily feature in (i) credit agreements without an express fallback provision (many of these being pre-2018 contracts) and (ii) credit agreements that may have contained explicit fallback language but which lacked “non-representativeness” transition triggers. In the case of (i), unless the credit agreements were remediated, borrowers faced significantly higher borrowing costs as the Prime Rate would be the remaining available rate in those agreements. The continued availability/ascertainability of LIBOR on a synthetic basis allowed borrowers to avoid – or at least postpone – that fate. In the case of (ii), given that the revised methodology of synthetic LIBOR mirrors the standard fallback rate of Term SOFR plus the ARRC spread adjustments, the continued availability/ascertainability of synthetic LIBOR has delayed the transition of those credit agreements until the end of this month, but in many cases the borrowing costs will not change at that time.
The impetus behind a synthetic version of LIBOR was pragmatism – the ability to reference an unrepresentative rate would provide parties with additional time to actively transition their loan agreements or to allow for such contracts to reach their expiration dates. Broadly speaking, regulators contemplated that a synthetic rate would ensure an orderly wind-down of USD LIBOR, particularly in the many jurisdictions around the world that rely on USD LIBOR as their primary benchmark and where parties may be further behind in the transition process.
Upon the cessation of synthetic Sterling LIBOR at the end of March, we noted that the end of synthetic rates should not affect a substantial portion of loan market participants. Nevertheless, directly affected parties will need to look critically at the language in their loan documents to determine what steps should be pursued.
According to Bloomberg, as of this writing, nearly $14 billion of syndicated loans remain benchmarked to USD LIBOR (with $4 trillion of syndicated loans having been successfully remediated!). For these contracts, parties may continue to reference the last published rate for the remainder of the reference period, depending on the interest rate tenors provided for in their respective agreements. This means that, for example, a borrower could elect six-month LIBOR on September 30 and that rate would apply until its next interest election at the end of March 2025. This gives further runway to borrowers who may need additional time to refinance the loan. For shorter interest period elections, loan market participants may need to anticipate an amendment process in the near term.
It is a helpful sign that more and more parties are looking to transition to the standard benchmark rate. According to Refinitiv and CME Group, Term SOFR has been used as a reference rate in $1.8 trillion of loans in 2024 YTD, compared to $1.47 trillion issued in the first half of 2023. (For parties looking to make the transition to SOFR, we flag the current CME licensing requirements for underwriters, as explained in this helpful presentation.)
The fate of interest rates has been a headline news item as of late, but parties should not lose sight of the September 30th deadline amidst the market chatter. Not only may it affect a meaningful (if not significant) segment of the market, but also it marks a milestone for the end of benchmark transition as we move into the final months of the year.
