Duane Morris LIBOR Transition Team leader Roger Chari recently published an article with Thompson Reuters Practical Law. He addressed several crucial questions that borrowers might have and gave some insight on navigating the options that are available as the end of LIBOR looms.
Further to our recent blog post on synthetic LIBOR, the Financial Conduct Authority (the “FCA”) has published its feedback statement on its consultation regarding the legacy use of 1, 3 and 6 month sterling LIBOR from 1 January 2022. The feedback consisted of 36 responses from market participants, with the majority of respondents agreeing with all aspects of the FCA’s proposals. The FCA has confirmed that it will permit legacy use of synthetic Sterling LIBOR by supervised entities, aside from cleared derivatives.
The FCA confirmed that one, three and six-month synthetic Sterling LIBOR will be calculated as the sum of the applicable one, three or six-month Term SONIA Reference Rates provided by IBA and the fixed spread adjustment applicable as part of the ISDA IBOR fallback for one, three or six-month Sterling LIBOR, which is published for the purposes of the ISDA IBOR Fallbacks Supplement and Protocol. IBA will be required to continue publishing synthetic Sterling LIBOR for all applicable London business days, except London public holidays.
It is of note that some market participants queried the use of forward-looking term RFR as a component for synthetic LIBOR, suggesting the use of RFRs “in-arrears” instead in order to align with ISDA fallbacks. The FCA’s response to this suggestion was that RFRs “in-arrears” are not suitable for contracts which require the interest rate to be identified up-front, and as such contracts are not realistically able to be amended to work using RFRs “in-arrears”, the use of such rates in the calculation of synthetic LIBOR could have the potential to cause market disruption.
As the cessation of LIBOR panels draws closer, the Financial Conduct Authority (the “FCA”) has been looking at ways to mitigate market disruption in respect of tough legacy loans which link to LIBOR but expire after LIBOR is discontinued. As a result, the FCA will require ICE Benchmark Administration to publish a synthetic Sterling LIBOR for the duration of 2022.
Despite at first instance appearing to be a solution for products which have yet to be amended for the cessation of LIBOR, synthetic LIBOR is only intended to be used for certain tough legacy contracts. To learn more about how synthetic LIBOR will work in practice and the legacy contracts which are likely to be able to utilize synthetic LIBOR, check out our Alert here.
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.
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.
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.
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.
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.
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.
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.