Attention Loan Market Participants: There are fewer than 145 days until US dollar LIBOR no longer is published on a representative basis.
Transition Progress to Date
While some segments of the market are well advanced in transitioning from the London InterBank Offered Rate (“LIBOR”) to the Secured Overnight Financing Rate (“SOFR”), the lending market generally is behind.
Bloomberg reports that “[r]oughly three-fourths of the $1.4 trillion US leveraged loan market still needs to flip [from LIBOR] to SOFR … to meet a deadline of the end of June….”1 The Loan Syndications & Trading Association (“LSTA”), citing LevFin Insights and JPMorgan Chase Bank, N.A., confirms that “approximately 80% of institutional loans and [Collateralized Loan Obligations] remain on LIBOR and need to transition….”2 Those estimates are consistent with the Financial Stability Board’s (“FSB”) December 16, 2022, Progress Report on LIBOR and Other Benchmarks Transition Issues (“FSB Progress Report”), which estimated outstanding LIBOR loan exposure at $2 trillion at the end of 2020.3
Regulators Reinforce Need to Act Now
In recent months, US regulators and advisory groups have made their views increasingly clear about LIBOR’s infirmities, the safest structure for SOFR, and the need for market participants to increase efforts to transition LIBOR-linked portfolios. In its December 16, 2022, Annual Report (“FSOC 2022 Annual Report”), the Financial Stability Oversight Council of the US Department of Treasury (“FSOC”) described LIBOR as “a key risk to financial stability, bank safety and soundness, and market integrity.”4 The FSOC 2022 Annual Report also noted and endorsed the ARRC’s position that—because widespread use of Term SOFR in cash products likely would cause an increase in Term SOFR derivatives, which could lead to a decline in the overnight SOFR derivatives markets that are essential to the construction of Term SOFR—use of Term SOFR should be limited.5 FSOC advises market participants to take advantage of any existing contractual terms or opportunities for renegotiation to transition their remaining legacy LIBOR contracts before the end of June 2023.6 FSOC reiterated its position on these matters at its Principals Meeting held on December16, 2022.
Reflecting the coordinated messaging and guidance of FSB, FSOC, the US Federal Reserve, and other US and global regulators, the Alternative Reference Rates Committee of the Fed (“ARRC”) on January 25, 2023, published its Summary of Key ARRC Recommendations (“ARRC Key Recommendations”), in which it emphasized acting now to remediate LIBOR contracts by using SOFR as a replacement rate, and communicating planned rate changes to related parties as soon as possible. The ARRC Key Recommendations repeated advice from the FSB Progress Report that market participants “avoid a ‘pile up’ situation at end of June 2023,”7 when a large number of contracts requiring fallback implementation and/or contract renegotiation will pose operational or market disruption risks.
LIBOR Act Unlikely to Assist Transition
A note of caution: As a general matter, loan parties should not be tempted to rely on the 2022 Adjustable Interest Rate (LIBOR) Act (signed into law on March 15, 2022, the “LIBOR Act”) and the related Regulations Implementing the Adjustable Interest Rate (LIBOR) Act (published in the Federal Register on January 26, 2023, starting the 30-day clock to effectiveness) to transition their LIBOR portfolios. The LIBOR Act applies to LIBOR contracts that contain no fallback provisions or that contain neither a specific benchmark replacement nor a determining person. However, because most LIBOR-linked loan agreements tend to include an Alternate Base Rate option (generally the highest of Prime, the Federal Funds Effective Rate + .5%, and LIBOR + 1%, which would constitute a “specific benchmark replacement”), these loans, if no action is taken to transition them to SOFR, will transition to Prime after June 30, 2023, a result that most consider undesirable.
Takeaway: Time Is of the Essence
The message to market participants is clear: Loan parties that still are using LIBOR as their benchmark need to transition now to a replacement rate, with SOFR being the preferred replacement.
As we quickly approach the all-important date of June 30, 2023, we highly encourage loan parties to contact their legal counsel prior to the end of the first quarter of 2023 to complete the transition of their loan contracts that remain linked to LIBOR. Given the volume of outstanding LIBOR contracts, time is of the essence.
2 Coffey, Meredith and Tess Virmani, LIBOR’s Ending! Act Now!, LSTA, January 18, 2023.
3 FSB Progress Report, pp. 4-5. Based on a 2021 LSTA progress report and a 2021 FSB survey, FSB states that, as of the end of 2020, there were an estimated US $70-95 trillion of USD LIBOR exposures expected to remain outstanding beyond the June 30, 2023, USD LIBOR cessation date, of which (a) 90% of the exposure is in derivatives, (b) approximately US $2 trillion is in bonds and securitizations, (c) approximately US $2 trillion is in business loans, and (d) approximately US $1 trillion is in consumer loans.
6 FSOC 2022 Annual Report, p. 61. And, of course, for more than two years, US regulators have “encouraged” supervised institutions to cease entering into new LIBOR contracts. The most recent guidance—the October 20, 2021 Joint Statement on Managing the LIBOR Transition—continues to be cited and recommends that the origination of LIBOR contracts cease after December 31, 2021.