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Countdown to the End of LIBOR: Transition Efforts Accelerate Ahead of June 30 Deadline

June 5, 2023

It is hard to believe that nearly six years have passed since Andrew Bailey, the then-CEO of the Financial Conduct Authority (FCA), sent shockwaves through the financial world by declaring the imminent end of LIBOR. Initially slated for the end of 2021, the cessation date for the publication of most USD LIBOR settings was eventually extended to June 30, 2023, allowing for an adequate transition period.

In the U.S., the responsibility of identifying a replacement rate for USD LIBOR fell to the Alternative Reference Rates Committee (ARRC). CREFC is a member of the ARRC.

Go Deeper. After an extensive evaluation process, the ARRC selected the Secured Overnight Financing Rate (SOFR) as the preferred alternative in June 2017. Following Andrew Bailey's announcement, the ARRC was reconstituted in March 2018 to develop comprehensive strategies facilitating the transition away from LIBOR across all cash products, including loans and securitizations.

The Countdown. Ever since, market participants have renegotiated contracts, updated systems and models, and incorporated fallback provisions into new agreements. The ARRC has played a crucial role in guiding this transition, offering guidance, establishing working groups, and enforcing deadlines to ensure market participants are well-prepared for LIBOR’s cessation.

For securitizations, the ARRC selected CREFC as a co-chair of the Securitizations Working Group (SWG). This collaborative effort has fostered increased awareness and adoption of alternative rates, marking a significant shift in the financial landscape.

In their most recent statement, released on May 31, 2023, the ARRC emphasized the importance of being prepared for the end of USD LIBOR. The statement urged market participants with LIBOR exposures to complete their transition efforts now, and to draw upon the resources and tools that have been made available. The statement also warned that those unprepared for the transition will face “significant ramifications, including uncertain and potentially unfavorable outcomes regarding their legacy LIBOR contracts along with operational disruptions.”

The countdown to June 30, 2023, has begun, and the coming months will be crucial as we bid farewell to the era of LIBOR. Financial institutions and market participants must be prepared and act proactively to safeguard the integrity of financial markets. While the end of LIBOR marks a significant milestone, it also opens doors to a new and improved era. The broader market's embrace of SOFR, along with the development of market conventions and the deepening liquidity in SOFR-linked instruments, has created a solid foundation for this new era.

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FCA ANNOUNCES DECISION ON SYNTHETIC USD LIBOR 

April 4, 2023

On April 3, 2023, the UK's Financial Conduct Authority (FCA) announced its decision to publish synthetic US dollar (USD) LIBOR as a temporary solution for tough legacy contracts referencing USD LIBOR outside the United States. The synthetic USD LIBOR will be based on CME's Term SOFR rate and the relevant ISDA fixed credit spread and will be published until September 2024, or 15 months after June 30, 2023, when the USD LIBOR panel is due to cease. 

The FCA emphasized that synthetic USD LIBOR rates will not be representative of the market that LIBOR is intended to reflect and will only be used in legacy contracts.

The FCA urged market participants not to rely on synthetic LIBOR and to transition to alternative rates wherever possible. Most contracts under US law should have workable fallbacks or will be covered by the LIBOR Act. Any contract with pre-cessation triggers will transition directly to SOFR and not reference synthetic LIBOR. The FCA aims to provide a temporary, unrepresentative solution to address the issue of tough legacy contracts referencing USD LIBOR outside of the United States until they can be transitioned to alternative rates.

It should be noted, however, that certain contracts under US law and not covered by the LIBOR Act may potentially continue to reference synthetic USD LIBOR. In particular, if LIBOR is unavailable, older loan contracts that do not contain a pre-cessation trigger but designate a specific, non-LIBOR fallback rate (such as Prime) would not be covered by the LIBOR Act. In this case, the contracts may consider the use of synthetic USD LIBOR. Market participants should review contracts with their legal counsel and understand how the fallbacks for each contract are expected to work.

 Given synthetic LIBOR's temporary and unrepresentative nature, the FCA has advised market participants not to rely on it; those that can transition should do so. This aligns with US Supervisory expectations that have long emphasized the expectation that market participants progress toward an orderly transition away from LIBOR.

Please see the FCA’s LIBOR transition webpage for further information. In addition, to help the CMBS community navigate the transition, CREFC recently published the LIBOR Legacy Playbook. Recognizing the importance of a well-executed and successful transition, the Playbook is primarily tailored to a servicer’s role in the transition of floating rate loans from a LIBOR index to a SOFR index. Nonetheless, many of the processes and procedures outlined may be helpful to other parties, such as certificate administrators, trustees, operating advisors, and rating agencies.

For any additional questions on the FCA decision or the LIBOR transition in general, please get in touch with Raj Aidasani or Lisa Pendergast.

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FCA Compels Publication of Synthetic USD LIBOR

November 29, 2022

On November 23, the UK’s Financial Conduct Authority (FCA) announced it would compel LIBOR’s administrator, the ICE Benchmark Administration (IBA), to publish USD LIBOR on a synthetic basis for 1-, 3-, and 6-month tenors after June 30, 2023. The FCA’s aim is to provide a temporary, unrepresentative solution for tough legacy contracts referencing USD LIBOR outside of the United States. The FCA is proposing that synthetic USD LIBOR be published for 15 months, permanently ceasing at the end of September 2024.

• The publication of a synthetic USD LIBOR is intended to address tough legacy non-US contracts not covered by the Adjustable Interest Rate (LIBOR) Act, enacted by Congress earlier this year.
• The Federal Reserve Board (FRB) has been tasked with implementing the LIBOR Act but has not yet issued its final rulemaking.
• The use of synthetic USD LIBOR will be limited solely to legacy contracts. The FCA also designated the rate as a “permanently unrepresentative benchmark,” allowing it to change its methodology.
• Synthetic USD LIBOR will be calculated as CME Term SOFR plus the relevant ISDA fixed spread adjustment (i.e., the same formulation used in the ARRC fallback language).
• The FCA considers this calculation to be “a fair and reasonable approximation… and one that is consistent with the replacement rates recommended by the FRB in its proposed rule.”
• It is important to note that while IBA has its own version of term SOFR, the calculation of synthetic USD LIBOR will only use the CME version.

Market participants are concerned about the potential for synthetic USD LIBOR to interfere with certain tough legacy US contracts. In particular, the concern lies with older loans (generally originated before 2018) that designate a specific, non-LIBOR fallback rate (such as Prime) if LIBOR is unavailable.

• These loans could potentially move to synthetic USD LIBOR, which fully aligns with the ARRC fallback language (i.e., term SOFR plus a spread adjustment).
• Moving to synthetic USD LIBOR would benefit borrowers as they would avoid the (generally) higher Prime Rate, while lenders and servicers would benefit by using the same LIBOR screen after June 2023.

It should be noted that CREFC, in its comment letter to the FRB regarding its proposed rule for the LIBOR Act, specifically asked for clarification on the treatment of synthetic USD LIBOR. As mentioned earlier, the final rule was expected by mid-September but has yet to be released.

Please reach out to Raj Aidasani with any questions.

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