Dechert on LIBOR – A New Year Special

2020 was a busy year for global benchmark transition, and the coronavirus pandemic did little to slow the pace. The end of 2020 saw an unexpected development that caused the market to pause – the potential delay of the cessation of all but two of the USD LIBOR tenors from the end of December 2021 to the end of June 2023.

In 2021, we continue preparing for the replacement of LIBOR. Our next “Latest from the LIBOR Front” webinar is set for Thursday, 4 February 2021 and Scott O’Malia, ISDA CEO will join us for our next LIBORcast.

Today, Monday 25 January, ISDA’s Fallbacks Protocol and Supplement¹ take effect. As 2021 transition efforts gather momentum, we have set out a helicopter view of our team’s current top five focus areas for LIBOR transition – the current state of play and what is to come:

1. Timing. The consultation by the LIBOR benchmark administrator, ICE Benchmark Administration Limited (IBA), launched in December 2020, seems almost certain to change the course of USD LIBOR transition timelines.² It is widely expected that the consultation will result in the end date of five of the seven USD LIBOR tenors being extended to summer 2023. Even if the cessation of these five USD LIBOR tenors is delayed, the proposed cessation date for publication of LIBOR remains unchanged for all other LIBOR currencies (GBP, CHF, EUR and JPY, and the two least-used USD tenors). The deadline for responses to this consultation is also today (25 January 2021), i.e., the same date that the ISDA changes take effect. In early December, ISDA hosted a webinar that discussed some of the issues around cessation. The webinar highlights that an "all USD tenor LIBOR" cessation announcement in early 2021 could cause the ISDA spread adjustment to fix as at that date, notwithstanding the fact that the spread will not be applied until the end of June 2023, when the rates are no more.³ Although the IBA consultation was quickly welcomed by regulators in the U.S. and UK, in so far as they provide additional time for existing USD LIBOR contracts to run off, their message remains unchanged – the focus should be on active transition.

2. Regulators. In In 2020, regulators across the US, UK, Europe and Asia increased their focus on LIBOR transition. Local regulators ramped up their LIBOR transition efforts and strengthened messaging, widely setting milestones for relevant local institutions. In the UK, for GBP LIBOR, the Financial Conduct Authority (FCA) and the Bank of England have already made clear what they expect from market participants in 2021.⁴ In summary, act now to remove reliance on GBP LIBOR settings in new business and legacy contracts where feasible to ensure preparedness in advance of the end of 2021, “the critical year for firms to complete their transition away from LIBOR”.

3. Transition to the Risk Free Rates (RFR) and term rates. The message remains that use of LIBOR in financial and other contracts should stop as soon as is practicable, generally speaking by 31 December 2021. U.S. banking regulators⁵ are encouraging U.S. banks to follow the same timeline. Other markets and regions have set shorter timeframes. In the UK, for example, by the end of Q1 2021, market participants are expected to cease initiation of new GBP LIBOR-linked loans, bonds and securitisations expiring after the end of 2021. This leads to a new focus on the RFRs. While SONIA is well established, a number of the other RFRs are not. The lack of alternative rates appears to be leading to anxiety and reluctance for market participants to transition away from LIBOR, in particular for USD-denominated products. In the case of USD LIBOR replacements, question marks remain around the suitability of SOFR as an alternative for certain types of financial products, and around the availability of a term rate based on SOFR. Term rates were in the headlines again recently with the publication of new term SONIA reference rates.⁶ There is also ongoing discussion among market participants and regulators around the determination of an appropriate credit spread adjustment.

4. Cross-market. The launch of the ISDA Fallbacks Protocol and Supplement in October 2020 marked a milestone moment for benchmark reform, and ISDA recently highlighted that “fallbacks and voluntary transition are very much meant to work in tandem”.⁷ EUR and USD-denominated cleared derivatives made the move to the RFRs in 2020. Whilst progress is generally slower in the UK and (in particular) U.S. cash markets, momentum is also gathering in the loan and bond markets. Loan market associations on both sides of the Atlantic and in Asia continue to progress transition efforts, with both the Loan Market Association (LMA) and the Loan Syndications and Trading Association (LSTA) publishing new related documentation as well as continuing market education and awareness efforts. Progress is slower in the bond markets although, as noted above, the latest roadmap produced for transition away from GBP LIBOR contemplates no new issuance of GBP LIBOR-linked bonds or securitisations after Q1 2021.

5. “Statutory solutions”. This is the moniker for legislative responses addressing LIBOR transition, which are principally focused on solutions to so-called “tough legacy” contracts, i.e., those contracts where transition from LIBOR to a RFR is likely to be impossible. There were major developments on this front in the U.S., UK and the European Union (EU) in 2020. The UK FCA launched consultations⁸ that closed on 18 January 2021 relating to certain aspects of proposed powers the FCA will have pursuant to amendments made to the UK Benchmarks Regulation by the UK Financial Services Bill (even though it does not yet have those powers), including the power to mandate an alternative methodology for LIBOR for use in "tough legacy" contracts. We await an update from the FCA on its next steps. In the EU, the final text of the related amendments to the (EU) Benchmarks Regulation are in the later stages of the EU legislative process.⁹ In the U.S., work continues at the federal level with a bill being authored by Representative Brad Sherman, and the so-called New York State legislative solution proposed by the Alternative Reference Rates Committee (ARRC) was included in Governor Cuomo’s state budget proposal.¹⁰

Footnotes

1) See 14 October 2020 note “LIBOR Transition – The Moment the Market has been Waiting For”.

2) See ICE website, section entitled “The Future of LIBOR” for full details on the IBA November announcements and the December IBA consultation, available here.

3) ISDA webinar: The Path Forward for LIBOR, 4 December 2020.

4) “The final countdown: Completing sterling LIBOR transition by end-2021”. Published by the FCA and the Bank of England on 11 January 2021. The Working Group on Sterling Risk-Free Reference Rates simultaneously published an updated priorities and roadmap, which can be found here.

5) “Statement on LIBOR Transition”, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, 30 November 2020.

6) 11 January 2021, “ICE Benchmark Administration Launches ICE Term SONIA Reference Rates as a Benchmark for Use in Financial Instruments”.

7) ISDA derivatiViews “Countdown to New Fallbacks”, 14 January 2021.

8) UK FCA, “Benchmarks Regulation: our proposed new powers, policy and decision making”.

9) The consolidated version of the text agreed between the Council of the European Union and the European Parliament was adopted by the European Parliament on 19 January 2021 (the related press release can be found here) and the current expectation is that the text will be published in the EU Official Journal in early February.

10) See here for related details.