LIBOR transition: Noteworthy Updates

Active transition of legacy GBP LIBOR contracts

In their 2021 priorities and roadmap, the Working Group on Sterling Risk-Free Reference Rates (“Working Group”) recommended the active transition of GBP LIBOR contracts across bonds, loans and derivatives, as follows:

• By end-Q1 2021, complete identification of all legacy GBP LIBOR contracts expiring after end-2021 that can be actively converted
• By end-Q3 2021, complete active conversion of all legacy GBP LIBOR contracts expiring after end-2021 and, if not viable, ensuring robust fallbacks are adopted where possible.

UK regulators subsequently supported these active transition milestones. “Active transition” refers to the situation where contracts referencing GBP LIBOR (and due to extend past the cessation date) are actively re-negotiated to reference SONIA, prior to the relevant cessation date. This can be distinguished from the situation where participants passively transition by relying on contractual or legislative fallback provisions.

Market participants are encouraged to take a risk-based approach when addressing outstanding GBP LIBOR exposures. As a first step, priority should be given to those contracts that do not yet contain fallback arrangements. Then, contracts that already include fallback provisions should be carefully assessed to determine their effectiveness and suitability. According to the Working Group, since not all existing fallback provisions are equally robust, careful consideration should be given before relying on these as a method to transition from GBP LIBOR to SONIA or other alternative rates. Market participants are also encouraged to consider the potential economic benefits of active transition upfront. It is also important that in any active transition scenario, market participants keep the relevant practicalities front of mind - including any requirements for consent amongst a number of contracting parties – and plan accordingly. 

In summary, market participants should not rest on their laurels now that industry safety nets have been provided through fallback provisions, such as those published by ISDA. Instead, an active and informed decision should be made, by contract, on the benefits of active transition versus passive reliance on fallbacks.

The paper published by the Working Group provides a useful comparison between reliance on ISDA’s IBOR fallbacks and active transition, across a range of factors. 

It is also worth noting that the expectation from UK regulators is that market participants should be prepared to demonstrate the steps they have taken to identify where active transition would be most appropriate, and to indicate how any residual risk from reliance on fallbacks will be managed. It will also be important to evidence that meaningful client engagement around the alternatives and their impact, has occurred. 

To echo recent remarks by ISDA’s chairman, the time is short, and firms should use it wisely. 

New York State LIBOR legislation signed into law

On 7 April, New York Governor Andrew Cuomo signed ARRC recommended LIBOR legislation into law, with an aim to facilitate a smooth transition from USD LIBOR and towards the designated successor rate, SOFR, specifically for certain tough-legacy contracts. 

Amongst other things, the legislation prohibits parties from refusing to perform contractual obligations or declaring a breach of contract as a result of the discontinuance of LIBOR or the use of a replacement; establishes SOFR as a commercially reasonable substitute for and a commercially substantial equivalent to LIBOR and provides a safe harbor from litigation for the use SOFR. The enactment of the legislation has garnered broad support amongst industry groupings who view it as a critical step to reducing operational and legal risks associated with the transition.

Industry support for similar federal-level legislation has gained significant support (to avoid possible state-level fragmentation). Market participants with outstanding USD LIBOR exposures are advised to keep close to these developments.

The text of the New York state legislation can be accessed here.

Continued work towards SOFR term rate

Although it remains US supervisory guidance that market participants should not wait for a term rate to transition away from USD LIBOR, work towards putting a term rate in place is ongoing. Market participants have long emphasized the need for such a forward looking alternative as a critical supporting tool for transition success. Building on previous statements, the ARRC has set out its principles for a forward-looking term SOFR rate, and released a set of market indicators that ARRC would consider in recommending a term rate. 

As a critical step towards a legitimate SOFR term rate, the ARRC announced at the end of May that it had concluded its RFP process and that CME Group was selected as the administrator for a term SOFR rate. This clears the path for the ARRC to formally recommend the term rate once the relevant market indicators are met.

 CME Group has also announced the publication of CME Term SOFR Reference Rates, a daily set of forward-looking interest rate estimates, published for 1-month, 3-month and 6-month tenors. An IOSCO compliance statement for these benchmarks has also been shared with the market.

Adoption of Risk-Free Rates – Major Development in 2021

 There have been a number of major developments in the relevant jurisdictions, and to keep yourself up to speed on all of these, we recommend that you have a look at the summary of developments published by ISDA. In that paper, ISDA sets out several of the major developments that have already been announced or are anticipated. The paper provides a useful overview for market participants, sets out the relevant target dates (down to product level in some instances) and milestones, and includes an overview of transaction volumes.