The last few months have seen the pace of change accelerate in the business loan market’s transition away from LIBOR. Several alternatives to the replacement benchmark rate recommended by the Alternative Reference Rates Committee (ARRC), the Secured Overnight Financing Rate (SOFR), gained momentum in the business loan market in the first part of 2021, and the ARRC and some regulators responded with efforts to highlight why SOFR should be the benchmark of choice. Set forth below are some of the milestones from an already eventful year, as well as some open questions to be worked through in the second half of 2021.
- On March 5, the UK Financial Conduct Authority (FCA) and ICE Benchmark Administration (IBA) formally confirmed that, as proposed late last year, most tenors of US Dollar (USD) LIBOR would survive until June 30, 2023, but all other IBOR currency rates (and some little-used USD LIBOR tenors) would terminate on December 31, 2021. On March 9 the Board of Governors of the Federal Reserve System (Fed) released SR 21-7: Assessing Supervised Institutions’ Plans to Transition Away from the Use of the LIBOR, to provide guidance to bank examiners in assessing progress by U.S. banks in their transition away from LIBOR. The Fed’s guidance provided more specific criteria for implementing the November 30, 2020 Interagency Statement on LIBOR Transition from U.S. regulators with primary responsibility for monitoring LIBOR transition (OCC, FDIC and the Fed), which directed that U.S. banks should issue NO NEW LIBOR after December 31, 2021, and should make sure legacy contracts referencing LIBOR that survive into 2022 have “robust” fallback language to a specific reference rate after that date. S. regulators, however, did not (and have not) required SOFR to be the substitute or fallback benchmark.
- The ARRC followed those announcements with a series of symposiums (March 22, May 11 and June 8) designed to reinforce the message that U.S. banks should quickly move away from LIBOR, sometimes featuring panels of corporate treasurers decrying the lack of LIBOR alternative options being offered to them by banks. The ARRC continued to recommend SOFR as the substitute reference rate of choice, and issued additional rounds of recommended fallback path language building in the SOFR-LIBOR margin, which was fixed in place with the FCA announcement noted above.
- The ARRC wound down its Credit Sensitive Rates working group, which it had convened throughout 2020 to explore the desire expressed by some market participants for a credit sensitive rate that reacted to market stress more like LIBOR, and contained forward looking term options. The developing consensus seemed to be that a forward looking term version of SOFR would likely not be available by the end of 2021, and at the March 22 SOFR Symposium, at least one presentation called into question the utility of forward looking term rates for the business loan market at all.
- Against this backdrop, credit sensitive alternative rates with forward-looking term options continued to make progress, with Bloomberg’s BSBY, IBA’s Bank Yield Index and American Financial Exchange’s AMERIBOR prominent among the alternatives. Bloomberg’s BSBY alternative launched in March with support from Bank of America, which began to offer both BSBY and SOFR options to its customers, depending on market space. BofA showed its support of BSBY as an alternative to SOFR by closing a $1 billion floating rate note issuance tied to BSBY (in a product that had shown early adoption of SOFR) in late April; executing the first BSBY swap transaction with JP Morgan Chase in early May; and closing a syndicated loan as left lead for a corporate borrower in mid May (the first in the market).
- This rapid advancement of BSBY and other credit sensitive alternatives as realistic competition for SOFR seemed to trigger some urgency around developing forward looking term SOFR sooner rather than later:
- On May 6, the ARRC identified a concrete set of market indicators that it will consider in evaluating whether forward looking term SOFR rates are ready to be used in the market:
- continued growth in overnight SOFR-linked derivatives volumes;
- visible progress to deepen SOFR derivatives liquidity, consistent with ARRC best practices: (a) offering electronic market-making and execution in SOFR swaps and swap spreads; (b) changing the market convention for quoting USD derivative contracts from LIBOR to SOFR; (c) making markets in SOFR-linked interest rate volatility products (including swaptions, caps, and floors); and
- visible growth in offerings of cash products, including loans, linked to averages of SOFR, either in advance or in arrears.
- On May 21 the ARRC selected CME Group as the administrator it plans to recommend for forward looking term SOFR once these indicators are met.
- To help advance the ball on deepening SOFR derivatives liquidity and meeting the ARRC’s criteria, on June 8, the CFTC announced its “SOFR First” initiatives, recommending primary market dealers to starting quoting USD swaps in SOFR, rather than LIBOR, as the primary reference rate by July 26. At the most recent SOFR Symposium on June 8, ARRC Chairman Tom Wipf expressed optimism that with the CFTC SOFR First initiative targeting July 26 for switching over to SOFR from LIBOR for quoting swaps, the ARRC could be in a position to endorse CME’s forward looking term SOFR rates within “days, not weeks” of that date.
- At the June 11 Financial Stability Oversight Council meeting, several regulators spoke optimistically about the near term availability of forward looking term SOFR rates, but were less enthusiastic about the recent progress of credit sensitive alternatives. The Fed’s Vice-Chair for Supervision, Randal Quarles, praised the depth of transactions backing SOFR as compared to credit sensitive alternatives, and noted that the ARRC supports other alternative rates for capital markets or derivatives products in only limited circumstances. SEC Chair Gary Gensler was more directly critical of credit sensitive rates in general and BSBY in particular, in both his FSOC comments and a concurrently released public statement, colorfully illustrating that BSBY suffers from the same issues that led regulators to push the market away from LIBOR: lack of liquidity, particularly in times of market stress, and relative ease of manipulation.
So, a few things we know going into the second half of 2021:
- Banks should stop issuing new LIBOR loans by the end of 2021, and start issuing new loans with a different benchmark, either SOFR or one of the other emerging credit sensitive rates. Progress has been slow but will need to pick up in Q3 and Q4, and bank regulators now have at least some of the Fed’s guidance on assessing that progress.
- Banks should be amending existing agreements that reference USD LIBOR to provide specific fallback paths.
- Banks should be amending existing agreements that reference foreign currency IBOR rates NOW, because the end is near for those rates.
Some potential open questions as we move into the second half of 2021:
- When regulators say “no new USD LIBOR after December 31”, what does that mean? Clearly, it means not closing new deals priced at USD LIBOR, but what about automatic renewals during 2022 when most tenors of USD LIBOR are still being published? Or what about uncommitted incremental facilities? Reasonable positions can be extrapolated based on existing guidance, but more specific guidance would be helpful.
- How will banks react to negative comments on credit sensitive alternative rates? Will that speed the first denovo syndicated bank credit facility tied to SOFR?
Check back here for further updates on benchmark replacement developments throughout what is sure to be an eventful second half of 2021.