Happy Bitcoin Pizza Day!

In case you haven’t heard of it, today marks the 14th anniversary of the first recorded use of bitcoin to pay for goods and services, the delivery of two large pizzas. With the price of bitcoin currently hovering around $70,000, it is shocking to hear that the price paid was 10,000 bitcoins. However, at the time, bitcoin was worth less than half a cent, around $0.0041, making the purchase price about $41.

While Bitcoin Pizza Day is a fun milestone for the cryptocurrency community to celebrate, in many ways the commercial use of bitcoin in the United States has not evolved much since 2010. Buying, holding and using bitcoin is generally not illegal, and the Financial Crimes Enforcement Network of the US Department of the Treasury has acknowledged that a seller may accept payments in bitcoin as a medium of exchange. However, bitcoin is still not legal tender (except in El Salvador). Sellers in the U.S. are not required to accept bitcoin, and most of them do not.

For banks that want to facilitate crypto payments by their customers, there are a number of hurdles to overcome. Pursuant to a joint statement on January 3, 2023 by the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, banks are “neither prohibited nor discouraged from providing banking services to customers of any specific class or type.” Nonetheless, the regulators believe that the holding of crypto assets by banks “is highly likely to be inconsistent with safe and sound banking practice,” and they are continuing to assess whether crypto activities “can be conducted in a manner that adequately addresses safety and soundness, consumer protection, legal permissibility, and compliance with applicable laws and regulations, including anti-money laundering and illicit finance statutes and rules.”

Alternatively, there are now a number of non-bank apps and other payment services that will convert bitcoin into dollars for purposes of facilitating payments. These services tend to be treated as money services businesses or money transmitters subject to strict anti-money laundering rules under the Bank Secrecy Act, FinCEN regulations and state law. Different states take varying views on the use of crypto, and these services may not be licensed to operate in every state.

In addition to these challenges, a buyer has to be careful of the tax law consequences of using cryptocurrencies to make purchases. Under Internal Revenue Service notice 2014-21, cryptocurrencies are property, and capital gains tax is due if the fair market value of the property or services purchased exceeds the purchaser’s adjusted basis in the cryptocurrency used to make the purchase. In other words, if a person bought one bitcoin in 2010 and used that bitcoin in 2024 to splurge for a Porsche (or a Bored Ape Yacht Club NFT) for $70,000, that person would owe capital gains tax on $70,000 (minus the $0.0041 cost of buying the bitcoin).

With all that in mind, spend your crypto wisely.

 

UCC Amendments for Digital Assets Effective in DC

On May 3, 2024, Law L25-0158 was published in the District of Columbia Register. Titled the “Uniform Commercial Code Amendment Act of 2024,” it is the codification in Washington, DC of the 2022 Amendments to the UCC drafted by the Uniform Law Commission and the American Law Institute. The 2022 Amendments hold out the promise of establishing uniform rules (at least in the US) for transferring digital assets such as cryptocurrencies and non-fungible tokens, and granting lenders a security interest in those assets that can be perfected by control.

Although the DC law is effective as of April 20, 2024, per the uniform transition rules adopted by the law, the provisions will not have substantive effect until July 1, 2025. This time delay was built into the rules to give market participants time to learn and adjust to the new rules and implement any changes that the new rules will require. Washington, DC is not the first jurisdiction to adopt the 2022 Amendments, but it is arguably the most important. Under the uniform choice of law rules in the 2022 Amendments, the UCC in effect in the District of Columbia will govern most, if not all, matters relating to perfection and priority of security interests in digital assets, at least for the foreseeable future.

Many questions and challenges are posed by the 2022 Amendments. Are all digital assets covered? Are cryptocurrencies money? Are digital tokens securities? What does it mean to perfect a security interest in a bunch of ones and zeros that only exist on a decentralized blockchain that isn’t located on a particular server or controlled by any particular entity? We will explore these and other issues in the coming weeks and months.

LIBOR Transition: Thanksgiving Surprise Consultation on Synthetic LIBOR

in case you thought it was safe to go away for Thanksgiving and not worry about LIBOR transition, think again. The Financial Conduct Authority, the regulator of US dollar LIBOR across the pond, reminded us that we are all still dependent upon them until the complete switch is made to SOFR or another rate.

On the Wednesday before Thanksgiving, the FCA issued its consultation on their consideration of a proposal to require publication of 1-, 3- and 6-month US dollar LIBOR on a synthetic basis for “a short period of time” until the end of September, 2024. Just to confirm, the consultation  paper reiterates that this would only apply to legacy loans- synthetic LIBOR would not be considered representative for purposes of allowing new LIBOR loans, and it would not apply to cleared derivatives. Comments are requested by January 6, 2023. Based on prior consultations, results will likely appear later in Q1, or Q2 2023.

The consultation contains a detailed discussion of the considerations in determining whether, and to what extent, synthetic LIBOR should be allowed, and how it should be calculated. As noted in the consultation, an additional 15 month period of time to allow legacy loans to expire on their own can help ease the transition for borrowers and lenders. A potential drawback is that lenders would have to continue tracking and using LIBOR alongside SOFR or other rates until all of their loans are transitioned or expire. Even if this is not a major burden, it still makes sense to transition to replacement rates where possible. One way or another, LIBOR will eventually cease.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. Huskins, and Phuong (Michelle) Ngo.

LIBOR Transition: Drama Continues for BSBY

As Bloomberg and banks like Bank of America in the US and DBS Bank in Singapore continue to push forward with BSBY, IOSCO last month rattled its saber with a statement on credit sensitive rates, highlighting the importance of choosing alternative financial benchmarks that are compliant with the IOSCO Principles. The last volley in the continuing back and forth between regulators and proponents of new credit sensitive rates came in July, when Bloomberg tried to address some of the volume and manipulation concerns raised by SEC Chair Gary Gensler and others with BSBY.

The IOSCO statement counters that with a caution that IOSCO compliance is not a one-time test, and even if trading volumes are sufficient for current volumes of loans in such benchmarks, loan volume should not be permitted to grow if it outpaces increases in underlying trading volumes and are unable to be resilient. BSBY is not mentioned by name, but it has been the primary subject of attention.

Two weeks after IOSCO published its cautionary statement, Gensler spoke at the ARRC’s fifth session of The SOFR Symposium: The Final Year, responding to Bloomberg’s July report that it “could not address the main concern that the rate is built off of too thin a market.” Gensler reiterated that that he did not “believe BSBY is, as FSB urged, ‘especially robust,’” adding that, “I don’t believe it meets IOSCO’s 2013 standards.”

Unless regulators back up their words with actions, this drama is mostly noise, and lenders are free to continue to make BSBY loans. Whether they will be successful will depend in part on whether borrowers perceive BSBY as a better deal. For legacy LIBOR loans, the spread adjustment added to the interest rate to transition to SOFR has been set by market convention—about 11.5 basis points for a 1 month term, 26bps for 3 months and 43bps for 6 months. This adjustment reflects that LIBOR is an unsecured rate that is sensitive to fluctuations in credit risk while SOFR is a secured, relatively stable “risk free” rate. Since BSBY is also based on unsecured transactions, there should not be a need to add much, if any, spread adjustment to transition from LIBOR to BSBY. This lower spread could be attractive to borrowers if they believe that over time, the variable credit sensitivity of BSBY will not cause the rate to rise, relative to SOFR, more than the fixed SOFR spread adjustment.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. Huskins, and Phuong (Michelle) Ngo.

LIBOR Transition: Derivatives News from CME Group

CME Group, the Term SOFR administrator, recently made a couple of important announcements. First, its Term SOFR data are now available for licensing for use in cash market financial products and OTC derivative products. Until now CME Group previously limited Term SOFR data to making loans. Their terms of use, which did not allow the data to be used for Term SOFR derivatives, have been updated with details on licensing.

Of equal importance, BSBY futures are live. As a complement to BSBY futures and SOFR-based offerings, CME Group also announced that it will launch Cleared BSBY swaps for both outright OIS and basis swaps beginning November 15, subject to regulatory review.

An active derivatives market is crucial to the development of Term SOFR and BSBY. With the availability of Term SOFR swaps, Term SOFR seems poised to replace LIBOR as the dominant rate in the loan market. As we discussed in our prior Alert, regulators, and SEC chair Gary Gensler in particular, have expressed considerable reservations with BSBY. It will be interesting to see how trading and loan volume in both rates develop.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. Huskins, and Phuong (Michelle) Ngo.

LIBOR Transition: The first syndicated SOFR loan is here!

We knew it was coming, but it finally happened.

Ford Motor Co. announced in June their intention to refinance $15.4 billion in syndicated facilities — and at least some of them on SOFR. With all eyes on what would be the first syndicated U.S. corporate loan tied to regulators’ preferred LIBOR replacement, Ford formally launched the deal this month. Bloomberg reported that there are three revolver tranches that Ford is refinancing (with JPMorgan Chase & Co. leading the loan process): a $3.35 billion three-year portion, a $2 billion three-year tranche and a $10.05 billion five-year portion. Ford’s loan is using Simple SOFR, and not Term SOFR endorsed by the ARRC earlier this summer.

This first syndicated loan originated on SOFR has marked a milestone in the transition away from LIBOR. And as the transition gains steam, more SOFR loans are expected to come in the last quarter of the year.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. Huskins, and Phuong (Michelle) Ngo.

LIBOR Transition: Term SOFR Formally Recommended… All Done?

On July 22, 2021, the Alternative Reference Rates Committee of the Federal Reserve Bank of New York (ARRC) followed up on its guidance from June and its confirmation on July 19 by formally recommending CME Group’s forward-looking SOFR term rates. After a roller coaster ride earlier this year, the messaging of the ARRC on Term SOFR settled down. Other than the mystery as to exactly when the announcement would be made, the statement was practically a nonevent. Proactive lenders that have been waiting patiently were quietly preparing their Term SOFR loan forms over the past few weeks. A flurry of new Term SOFR loans should not be far behind.

With this development, it might seem that the market has all the tools that it needs to transition to SOFR. Time for high-fives and a victory lap!

Not so fast. As those who have been living through the transition over the past few years can attest, there is always another issue to address. In this case, it’s interest rate swaps. Check out our recent Alert for a discussion on this issue.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. Huskins, and Phuong (Michelle) Ngo.

LIBOR Transition: What’s a Borrower to Do?

So far, much of the focus has been on getting lenders to stop originating LIBOR loans in favor of loans based on alternative, risk-free rates. As we get closer to that becoming a reality on a broad scale, it’s worth taking a look at the issue from a borrower’s perspective. Borrowers have no say in the phaseout of LIBOR, but to varying degrees they will have a say in which alternative rates will become prevalent in the market.

To learn about what a borrower should do in light of the availability of alternative reference rates in the very near future, check out our Alert here.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. Huskins, and Phuong (Michelle) Ngo.

LIBOR Transition: Release the CRITR?

It doesn’t sound quite as scary as the mythical monster from Scandinavian folklore, but it’s not intended to be. CRITR is not a complete game changer in LIBOR transition or trying to be one. What is it then?

The Credit Inclusive Term Rate (CRITR) and the spread only Credit Inclusive Term Spread (CRITS) are the latest products of IHS Markit, a $44 billion company that is set to merge with S&P Global later this year. IHS Markit initially developed CRITS to provide the market with an alternative credit sensitive spread over SOFR. When Term SOFR failed to materialize, it developed CRITR as a standalone credit sensitive rate with forward looking tenors similar to LIBOR.

In a crowded field with Ameribor and BSBY in addition to SOFR, and Term SOFR likely coming by the end of July, and regulators expressing concern about rates other than SOFR, and borrowers not too keen on credit sensitive rates, is there room for a new rate option?  Interest rates are a diverse, multi trillion dollar market, and even a small sliver of it can be lucrative if the rates take hold. Is it right for you? We discuss CRITR and CRITS in more detail in our recent Alert.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. Huskins, and Phuong (Michelle) Ngo.

LIBOR Transition: News Flash- Borrowers Don’t Like Volatile, Credit Sensitive Rates

So far, much of the emphasis on LIBOR transition has been on lenders. As we all wait for alternative rates to hit the market, the Association for Financial Professionals, the National Association of Corporate Treasurers and the U.S. Chamber of Commerce joined in a letter to voice the concerns that borrowers have about the pace of the roll out to the Department of the Treasury, the Federal Reserve, the SEC and the CFTC.

This message isn’t surprising, but the letter contained another component that is worth highlighting. When asked if they prefer SOFR or “potential credit sensitive rates that could move up like LIBOR has done in times of economic stress”, roughly 85% of borrowers surveyed chose SOFR. Put that way, it’s surprising that even 15% of borrowers preferred credit sensitive rates.

Is this the death knell for credit sensitive rates like Ameribor and BSBY before they even get off the ground? Should borrowers really pick only SOFR? The answers are not as simple as they may seem. In our recent Alert, we discuss some of the considerations that borrowers, and lenders that are planning in earnest to offer credit sensitive alternative rates, should keep in mind.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. Huskins, and Phuong (Michelle) Ngo.

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The opinions expressed on this blog are those of the author and are not to be construed as legal advice.

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