Phaseout of LIBOR: Navigating the Final Stages, Implementing New Reference Rates and Fallback Language

Description

All remaining U.S. dollar LIBOR tenors will end on June 30, 2023. U.S. financial institutions generally stopped new LIBOR originations after December 31, 2021. Real estate and finance counsel must understand now the LIBOR transition and replacement rate landscape when drafting or reviewing loan and securities documents.

The Alternative Reference Rate Committee's (ARRC) recommended replacement rate for U.S. dollar LIBOR is the Secured Overnight Financing Rate (SOFR). The Federal Reserve Bank of New York has published overnight SOFR rates since April 2018 and compounded SOFR averages over rolling 30-day, 90-day, and 180-day periods since March 2020. The ARRC also has recommended 1-, 3-, 6- and 12-month CME Term SOFR, published by the CME Group Benchmark Administration Limited, for use as the first fallback in all cash products using the ARRC's previously published "fallback language" and for some new cash products, including loans.

Now that SOFR is available in various forms, counsel should understand the available alternatives when advising clients how to implement alternative rates in contracts and securities. The credit spread adjustment added to SOFR in new deals is negotiable. Moreover, banks are not required to use SOFR, and many are using or considering alternatives, including "credit-sensitive rates" that include some measure of the cost of unsecured borrowing. "Credit spread add-ons" to SOFR are also in the works, adding to the myriad of choices about which counsel and clients have questions.

The Adjustable Interest Rate (LIBOR) Act, signed into law on March 15, 2022, establishes a national framework for replacing LIBOR in contracts lacking adequate fallback provisions. By operation of law, the Act effectively replaces references to LIBOR in "LIBOR contracts" with some form of spread-adjusted SOFR. The legislation solves a sticky problem of "tough legacy contracts" that are impractical or impossible to amend and provides a unified federal solution, which if left to the states, could have resulted in detrimental differences in replacement rates. However, the Board of Governors of the Federal Reserve must promulgate rules to provide additional details necessary to implement the Act, and we have yet to see any proposal. Proposed regulations are expected by September.

Finance counsel should review existing LIBOR-based instruments and discuss alternative rates and the potential application of the LIBOR Act with their clients. If parties can agree on an alternative rate, they should consider switching now rather than waiting until LIBOR ends. Parties should also consider how best to adjust hedging strategies. If parties prefer to switch away from LIBOR when it ends, counsel should incorporate appropriate hardwired fallback language that specifies the replacement rate and any corresponding spread adjustment. The LSTA has published forms of amendment that can be used to amend loan agreements that incorporated the ARRC's previously recommended “hardwired approach” or "amendment approach.”

Listen as our authoritative panel discusses the timing and impact of the LIBOR phaseout, the use of SOFR and other alternative rates and the remaining transition challenges. The panel will explain the new federal law and how it should bring more certainty to what will happen to "tough legacy contracts."