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Banking Law

Transitioning Away from LIBOR: What’s Next?

The transition away from LIBOR, the abbreviation for the London Interbank Offered Rate, has left many asking, what is next? LIBOR is set to be phased out at the end of 2021. As of June 2017, the Alternative Reference Rates Committee (“ARRC”) of the Federal Reserve Bank of New York (“Federal Reserve”) has designated the Secured Overnight Financing Rate (“SOFR”) as LIBOR’s replacement here in the United States. The use of SOFR as the replacement for LIBOR is not mandated by federal law, but rather recommended by the ARRC. Other replacements to take LIBOR’s place include the United States Prime Rate and Ameribor. However, SOFR, with its backing from the ARRC, appears to be the front runner.

LIBOR has served as the benchmark interest rate for over 30 years and is currently tied to over $200 trillion in contracts and debt obligations. LIBOR serves as the underlying interest rate for multiple types of contractual obligations including business loans, mortgages, and even student loans. However, given the recent LIBOR rate setting manipulation scandal and its declining reliability, the United Kingdom’s Financial Conduct Authority has agreed to stop publishing the LIBOR, and banks will no longer be obligated to make LIBOR submissions, after December 31, 2021. SOFR is calculated daily based on overnight cash lending between banks collateralized by the United States Treasury in the repurchase agreement market. According to the Federal Reserve, SOFR is much more resilient than LIBOR is numerous ways including its transparency and the fact that it is more representative of the way financial institutions fund themselves today. The Federal Reserve began publishing daily SOFR rates on its website on March 2, 2020.

The ARRC has created the Paced Transition Plan to give guidance and encourage the adoption of SOFR here in the United States. The ARRC has recommended that contracts stop referencing LIBOR as the benchmark interest rate starting as early as this year in order to facilitate a smooth transition to SOFR by the end of 2021. Some financial institutions have already begun the transition process to SOFR, such as Freddie Mac, which will no longer purchase LIBOR Adjustable Rate Mortgages beginning January 1, 2021.

In addition to providing a transition timeline, the ARRC recommends that LIBOR contracts should, as soon as possible, include ARRC recommended, or substantially similar, fall back language. Two approaches for fallback language have been enumerated by the ARRC for those instances where a contract is still using LIBOR as an interest rate or for those previously executed contracts that do not provide for an alternative to LIBOR. The first approach, the “hardwire approach”, specifically sets forth a replacement benchmark interest rate that will be applied at the end of LIBOR and indicates the procedures that will be used to calculate and institute the new interest rate within the contract. Alternatively, the “amendment approach” permits the parties to a contract to amend the agreement at a future date, once LIBOR is phased out, and determine the new interest rate then, while still outlining the procedures that will govern selecting the replacement index. The hardwire approach eliminates the need for an amendment down the road for LIBOR based contracts by including language that addresses the potential replacement, while the amendment approach may work best for those older contracts that may not have anticipated the end of LIBOR. Either way, it is imperative that both approaches address how the new interest rate will be determined.

Whether it be assistance amending an executed contract or current debt obligation that does not include replacement language for LIBOR, or assistance navigating new contract negotiations and loan agreements, our experienced team of attorneys here at Dawda Mann are ready to advise and help guide you through the transition away from LIBOR.

Written by Associate, Kathryn Kaleth.