As previously discussed here, LIBOR (the London Inter-Bank Offered Rate) is an interest rate benchmark that is used as a reference rate for a wide range of financial transactions. It is typically offered as a floating rate interest option for corporate borrowers in the US loan market. Corporate borrowers may pay interest on their loans based on LIBOR (typically, LIBOR plus a spread, or applicable margin).
ICE Benchmark Administration (IBA), the administrator of LIBOR, announced on November 30, 2020 that it expects to consult on its intention to cease publication of one-week and two-month LIBOR on December 31, 2021, and the remaining USD LIBOR settings on June 30, 2023 (IBA later clarified that this was not an announcement that IBA will cease the publication of LIBOR). See our blog article here for a discussion of the potential effects of the COVID-19 pandemic on cessation of the LIBOR publication. As the likely end of the most commonly used LIBOR periods remains approximately two and a half years away, most existing agreements utilizing USD LIBOR will mature prior to the expected end date.
Notwithstanding the future termination of LIBOR, several United States regulatory authorities, including the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, issued a joint statement supporting a transition away from using LIBOR “without delay” regardless of the unclear end date. These authorities further advised that successor language be included in financial agreements to preemptively provide an alternate interest rate after discontinuance of the existing reference rate.
Attorneys drafting new loan agreements and amendments to existing loan agreements utilizing LIBOR have taken two approaches to establish a successor interest rate following the cessation of LIBOR, namely the “amendment approach” and the “hardwired fallback language approach.” Under the amendment approach, the loan document provides the parties will cooperate to amend the applicable interest rate provisions to incorporate a new interest rate. This approach requires the parties to reach agreement on the terms of the new rate and to execute amendments to reflect this agreement. Under the hardwired fallback language approach, the fallback language provides for the successor rate within the original agreement and generally removes the need for a future amendment.
Both approaches provide for several triggers to transition from LIBOR to the successor reference rate including notice of the cessation of LIBOR, agreement among the parties to transition to the successor rate, or both. For the LIBOR cessation notice language, the agreement may provide that successor rate provisions will become effective if certain sources announce the termination of publication of LIBOR, regardless of whether those provisions provide for the amendment approach or the hardwired fallback language approach. For the election language, certain specified parties to the agreement (whether that be one, some or all of the parties) can elect to transition to the successor rate as provided for in the agreement.
The Alternative Reference Rates Committee (ARRC), a committee created by the Federal Reserve, released recommended USD LIBOR fallback contract language for syndicated loans to deal with the transition, in which it recommended either approach. For the hardwired option, the successor rate proposed by ARRC was Term SOFR plus a spread adjustment, or if that does not exist Compounded SOFR plus a spread adjustment, if neither exist, the hardwired approach reverts to an amendment approach, giving due consideration to relevant governmental body recommendations or evolving or then prevailing market conventions. The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.
In 2019, the International Swaps and Derivatives Association (ISDA®) determined that the fallback for LIBOR in their documentation would be Compounded SOFR in arrears together with a spread adjustment based on a historical median approach.
In June 2020, ARRC revisited and revised its position regarding LIBOR transition. Consistent with the ISDA® documentation, only the hardwired approach is now recommended, with the amendment approach being deleted. In addition, contrary to both its prior position and the ISDA documentation, rather than using Compounded SOFR in the second level of the waterfall of alternative benchmark replacements, ARRC now recommends Daily Simple SOFR.
Initially, the amendment approach was more commonly used; however, in light of the ARRC and ISDA® documentation and recommendations, the hardwired fallback language approach has become more prevalent in recent months.
David Paseltiner is chair of the firm’s corporate and commercial transactions practice group and a member of its banking and financial services practice group. He represents businesses in a wide variety of industries, ranging in size from small start-ups to well established firms with national and international operations. He also represents individuals in connection with employment agreements, shareholders agreements and operating agreements. David can be reached at 516-393-8223 or firstname.lastname@example.org. Rose C. Egan, an associate in the corporate and commercial transactions practice group, assisted in the drafting of this article.