On November 30, 2020, ICE Benchmark Administration (“IBA”), the administrator of U.S. Dollar LIBOR (“USD LIBOR”) and other IBORs, lowered the pressure with respect to the upcoming cessation of USD LIBOR. IBA announced that, following a consultation in December and January, (i) it intends to cease publication of 1-week and 2-month USD LIBOR at the end of 2021 and (ii) subject to compliance with applicable regulations, including as to representativeness, it does not intend to cease publication of the remaining USD LIBOR tenors until June 30, 2023.1 This IBA announcement followed an earlier IBA announcement on November 18, 2020, that all GBP, EUR, JPY, and CHF IBOR tenors would cease publication after December 31, 2021.
U.K. and U.S. regulatory authorities, in guidance that appeared to be coordinated with the IBA announcement, quickly responded with supporting statements regarding the timing of USD LIBOR cessation and the effect of the IBA announcement on the transition plans of market participants. According to the U.K. Financial Conduct Authority (“FCA”), clarifying the end date for USD LIBOR will “incentivize swift transition, while allowing time to address a significant proportion of legacy contracts that reference USD LIBOR.”2 The FCA’s announcement was issued in tandem with a joint statement of the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (applicable to the financial institutions that they regulate),3 and a press release by the Board of Governors of the Federal Reserve System,4 and is consistent with the July statement by the Federal Financial Institutions Examination Council.5
The statements by the U.S. regulators shared the following main points, which apply to their regulated institutions but have implications for other market participants:
- Banks are encouraged to stop entering into new USD LIBOR contracts “as soon as practicable,” and by no later than December 31, 2021;
- Entry into such contracts after December 31, 2021, would create safety and soundness risks for banks;
- The USD LIBOR June 30, 2023, cessation date will allow more time for existing legacy USD LIBOR contracts to mature; and
- Banks should use this extra time to continue to prepare for the transition away from LIBOR.6
IBA issued the proposed consultation on December 4, 2020.7 It is open for comment until January 25, 2021. IBA has noted that the consultation is required under its Changes and Cessation Procedure, which requires that IBA’s Consultation Policy apply “[i]f cessation of some or all of the LIBOR settings were under consideration.”8 The consultation, therefore, appears to be driven by procedural requirements, rather than uncertainty about the LIBOR cessation path proposed by IBA and supported by UK and U.S. regulators. IBA plans to share the results of the consultation with its regulator, the FCA, “and to publish a feedback statement summarizing responses from the consultation shortly thereafter.” We expect that IBA will release that feedback statement in February and reaffirm the cessation plans that it announced in November.
Effect on Floating Rate Notes
Two groups that are most likely breathing a large but temporary sigh of relief are (i) issuers of legacy USD LIBOR floating rate notes without updated fallback provisions (“Legacy FRNs”) and (ii) the trustees for these Legacy FRNs. Issuers and trustees have been concerned about potential liabilities arising from Legacy FRNs and how to reduce the risk of those liabilities. Assuming that the IBA consultation is completed favorably and in a timely fashion, there is now an additional 18 months of lead time before Legacy FRNs, if no action is taken, will default into fixed rate notes. Potential solutions that have been discussed include exchange offers, tender offers, consent solicitations, and state and federal legislative solutions.
The proposed delay in USD LIBOR cessation would allow some short term Legacy FRNs to mature before June 30, 2023. Issuers are surely crossing off such Legacy FRNs from their worry list right now. The delay would also allow more time for back-office systems to prepare for secured overnight financing rate (“SOFR”) calculations, which will be required when more recently issued USD LIBOR FRNs that include the Alternative Reference Rate Committee’s (“ARRC”) USD LIBOR-to-SOFR fallback provisions switch over to SOFR upon a USD LIBOR cessation.
Nonetheless, issuers of Legacy FRNs should not let their guard down. It is not certain that the IBA consultation will result in an extension of the currently anticipated date of USD LIBOR cessation for the subject tenors. While awaiting the results of the IBA consultation, issuers of Legacy FRNs should continue to consider potential solutions based on a December 31, 2021, USD LIBOR cessation. Those potential solutions will be helpful for Legacy FRNs that mature after June 30, 2023.
We note that the IBA’s proposed plan to cease publication of 1-week and 2-month USD LIBOR on December 31, 2021, poses no concern for the USD LIBOR FRN market, which generally bases interest rates on 3- and 6-month USD LIBOR.
Effect on Syndicated Loans
Participants in the multi-trillion dollar U.S. syndicated loan market also can breathe a sigh of relief, but are not quite ready to put down their pencils. Again assuming that the IBA consultation is completed favorably and that mechanisms are put in place to ensure USD LIBOR continues to be quoted and representative through June 30, 2023, the additional 18 months to transition these loans will be tremendously helpful, both in terms of the number of loans that will mature or be refinanced during that extended period, and in terms of avoiding the monumental administrative task that will be involved with transitioning thousands of transactions and loan documents to a replacement rate over a relatively short period of time.
Lenders and borrowers still should plan to cease new originations of loans bearing interest based on USD LIBOR and should be prepared to shift new loan originations to a replacement rate, such as SOFR, by the end of 2021. In the case of bank lenders, failure to do so can be expected to draw the ire of regulators, and absence of a robust market for SOFR loans would lead to “kicking the can down the road” in terms of transitioning legacy USD LIBOR loans to a replacement rate. This failure again would result in the huge administrative task of transitioning a large volume of legacy contracts over a short period of time in 2022 and the first half of 2023 (though presumably at that point, with more robust replacement mechanics in more contracts, the burden would be less than transitioning all USD LIBOR loans to replacement reference rates in 2021).
Lenders and borrowers also should ensure going forward that all newly originated loans, and all extensions or refinancings of existing loans, include hardwired fallback language for USD LIBOR, such as that recommended by the ARRC, or other formulations that allow a more streamlined transition to a replacement rate than the prior “amendment” fallback language (and, even more so, than traditional loan documents that do not have more recent LIBOR fallback language and fall back to the “Base Rate” (i.e. the prime rate)). Historically, lenders and borrowers have been reluctant to update or add LIBOR fallback language when a new loan tranche is being added to or refinanced in a credit agreement and the approval of existing lenders is not needed, since the market has taken the view that adding or changing LIBOR fallback language requires the approval of 100% of lenders. Lenders and borrowers may want to consider adding hardwired fallback provisions in these documents, even if they would apply only to the newer tranches, thereby ensuring that at least those new or refinanced loan tranches would be subject to a more streamlined transition at the appropriate time (and many of the other existing tranches not subject to those hardwired provisions could mature or be refinanced at a later time and before June 30, 2023).
Refinancing activity has been particularly depressed in 2020 due to market conditions, so inclusion of hardwired fallback provisions (or similarly streamlined fallback provisions) in as many transactions as possible going into 2021, and a move to origination of loans bearing interest based on SOFR or other replacement rates in 2021, will be particularly important. As the market improves and refinancing activity increases, these actions will help to avoid increasing the volume of legacy loans that require transition before June 30, 2023.
Effect on CLOs
As with Floating Rate Notes, outstanding LIBOR-referencing U.S.-managed Collateralized Loan Obligations (“CLOs”) without robust fallback provisions for all of their floating-rate securities (“Legacy CLOs”)—which we understand to be in the range of 10-20% of outstanding CLOs9—will have a reprieve, assuming that the IBA consultation results in an extension of the publication of most tenors of USD LIBOR, including 1- and 3-month tenors, through June 30, 2023. Virtually all U.S. CLOs reference 3-month USD LIBOR for floating-rate notes.
It appears that most Legacy CLOs would require 100% consent of Noteholders for any supplemental indenture to replace LIBOR or add robust fallback language, which, short of being done as part of a full refinancing or a reset, may not be possible to obtain given the number of holders, competing interests between debt and equity, and similar complications. An extension of the publication of most tenors of USD LIBOR to June 30, 2023, would greatly enhance the utility of a variety of other solutions for Legacy CLOs that do not have a stated maturity prior to July 2023, including:
1) Refinancing. Just as robust fallback language has been added to CLO notes that have been refinanced over the last few years, there may be opportunities for refinancing Legacy CLO notes over the next 2-½ years, which concurrently will allow the addition of robust fallback language. Since the beginning of the COVID-19 crisis, refinancing activity has been depressed. A longer period of time until relevant USD LIBOR cessation will increase the likelihood that liability spreads will have tightened to ranges that support refinancing activity sufficiently in advance of LIBOR cessation. To that end, the advent of vaccines, as well as other factors, may lead to a revival in refinancings well in advance of the end of June 2023. In fact, it has been reported as we publish this article on December 7 that a large CLO manager is preparing to refinance four tranches (through BBB-) of a 2014-vintage CLO, and there are indications of a coming wave of refinancings and resets as 2021 approaches.
2) Legislation. Legislation supported by the ARRC has been introduced (and expected to be reintroduced in 2021) in the New York State Legislature that would mandate or permit replacement of LIBOR with an ARRC-recommended reference rate in New York law-governed contracts (such as CLO indentures) with LIBOR-based or polling-based fallback language like that seen in essentially all Legacy CLOs. Similar legislation is expected to be introduced in the United States Congress in early 2021. If either or both of the New York and Congressional proposed statutes is enacted by July 2023, such legislation could be expected to facilitate LIBOR replacement in those Legacy CLOs where the relevant floating rate notes have not been refinanced.
3) Judicial Instruction Proceeding. If legislation is not enacted, judicial proceedings may be brought by CLO trustees and/or calculation agents, or other transaction parties, seeking judicial instruction on how the reference rate should be calculated upon LIBOR cessation. An extension of the publication of select USD LIBOR tenors through June 30, 2023, likely will make it less urgent to commence such proceedings, possibly until after there is more clarity on the likelihood of success of the proposed legislation discussed above.
The November 30, 2020, IBA announcement and related regulatory statements may slow the transition away from LIBOR-based new issuance in the U.S. CLO market. The ARRC recommended earlier this year that no CLOs referencing USD LIBOR should be issued after September 30, 2021. However, this was in the context of the ARRC’s recommendation that no syndicated loans referencing USD LIBOR should be entered into after June 30, 2021. In the wake of the IBA’s statements, it is possible that origination of USD LIBOR-referencing syndicated loans will extend beyond June 30, 2021. As noted above, U.S. bank regulators continue to target an “as soon as practicable” deadline, but no later than December 31, 2021, for cessation of new USD LIBOR-referencing contracts; however, CLO participants may determine that for a CLO launching in late 2021, LIBOR, with robust fallback language, is appropriate to be used for the intervening 18 months prior to cessation of 3-month USD LIBOR. Indeed, many U.S. CLOs have been launched this year with one-year non-call periods, allowing floating rate notes to be refinanced or redeemed prior to July 2023.
Nonetheless, with respect to fallback language, U.S. bank regulators in their November statement “encourage banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021,” adding that “new contracts entered into before December 31, 2021, should either utilize a reference rate other than LIBOR or have robust fallback language that includes a clearly defined alternative reference rate after LIBOR’s discontinuation.” In light of this statement, the trend favoring use of fallback language that either tracks, or comes close to tracking, the hardwired fallback language recommended by the ARRC can be expected to continue.
That said, we anticipate continued divergence from the ARRC recommendations to some degree. For example, whereas the ARRC securitization recommendations provide that if Term SOFR is not available, then Compounded SOFR should replace LIBOR, some recently launched CLOs provide that the fallback for unavailable Term SOFR will be Daily Simple SOFR, to match the ARRC’s recommendations for syndicated loans. Relatedly, some new CLOs condition the introduction of certain replacement rates on their use in some required percentage of the floating rate loans in the CLO’s underlying portfolio.
Finally, because of the longer period of time during which LIBOR will be available, there is an increased likelihood that Term SOFR will be available by July 2023, when USD LIBOR no longer will be quoted.
In summary, although the well-received news of the IBA consultation is generating a lot of questions, for difficult-to-amend legacy products, at least, it has provided very helpful answers.
1 The IBA announcement is available at: https://ir.theice.com/press/news-details/2020/ICE-Benchmark-Administration-to-Consult-on-Its-Intention-to-Cease-the-Publication-of-One-Week-and-Two-Month-USD-LIBOR-Settings-at-End-December-2021-and-the-Remaining-USD-LIBOR-Settings-at-End-June-2023/default.aspx
2 The FCA announcement is available at: https://www.fca.org.uk/news/statements/fca-response-iba-proposed-consultation-intention-cease-us-dollar-libor
3 The joint statement is available at: https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20201130a1.pdf
4 The Federal Reserve Board press release is available at: https://www.federalreserve.gov/newsevents/pressreleases/bcreg20201130b.htm
5 The FFIEC statement is available at: https://www.ffiec.gov/press/PDF/FFIEC%20Statement%20on%20Managing%20the%20LIBOR%20Transition.pdf
6 In a webcast hosted by ISDA on December 4, 2020, Edwin Schooling Latter and other speakers made clear that market participants are expected to continue active transition away from LIBOR. “[T]his does not give market participants a reason to not adhere to the ISDA IBOR Fallbacks Protocol or otherwise defer transition in relation to U.S. dollar LIBOR.” The transcript of the webcast is available at: http://assets.isda.org/media/f1a442f2/80e230bf-pdf/.
7 ICE LIBOR Consultation on Potential Cessation is available at: https://www.theice.com/publicdocs/ICE_LIBOR_Consultation_on_Potential_Cessation.pdf.
8 IBA’s Changes and Cessation Procedures, which cites and links to IBA’s Consultation Policy, is available at https://www.theice.com/publicdocs/BMR_LIBOR_Change_Cessation_Procedure.pdf.
9 Among the studies analyzing legacy contracts, including CLOs, is a report by S&P Global Ratings, available at: https://www.spglobal.com/ratings/en/research/articles/201006-as-the-deadline-for-the-transition-from-libor-approaches-work-remains-for-u-s-structured-finance-11674750.