On November 30, 2020, the financial markets experienced a coordinated and multijurisdictional initiative to reset the course of U.S. dollar LIBOR transition. The administrator of LIBOR, ICE Benchmark Administration (IBA), announced that it would consult on ceasing to determine one-week and two-month U.S. dollar LIBOR with effect from the previously-announced December 31, 2021 deadline but – and this is very significant - ceasing to determine the remaining U.S. dollar LIBOR tenors on June 30, 2023. This announcement coincided with an announcement by ISDA that the IBA announcement was not a triggering event which would set the spread to be used in its derivative contracts as part of the risk-free rate determination process.
The U.S. Federal Reserve Board, the OCC, and FDIA lauded the announcement at the same time as clarifying that the extension was only of relevance for legacy U.S. dollar LIBOR-based contracts. The coordinated initiative also saw the UK’s Financial Conduct Authority (FCA) state that the announcement did not mean that any LIBOR rate was unrepresentative.
So, what does this all mean? Foremost, it means that U.S. dollar LIBOR will very likely continue to be determined until June 30, 2023. Even though the one-week and two-month U.S. dollar LIBOR rates may cease to be published after the end of 2021, it will still be possible to calculate them using linear interpolation until the other U.S. dollar LIBORs cease at the end of June 2023.
This also means that there has been a very substantial change of heart by the U.S. dollar LIBOR panel banks that provide the quotations for the IBA determination of U.S. dollar LIBOR. Until now, the FCA had reached an agreement that the panel banks would commit to providing LIBOR quotations until the end of 2021, and this had formed the basis of the regulatory timetable to LIBOR transition. To now consult on extending the determination until June 30, 2023 indicates that there must be a basis for assuming that the U.S. dollar LIBOR panel banks will continue to participate in the rate setting process for U.S. dollar LIBOR until then. This is reinforced by the FCA’s statement that its discussions with the panel banks were to achieve collective confidence that a sufficiently strong and representative rate could be maintained until an orderly end date for the panel.
IBA is also consulting on ending the calculation of LIBOR for euro, sterling, yen, and Swiss franc LIBOR at the end of 2021. Despite the bifurcated end dates for LIBOR, this does mean that an IBA announcement after its consultation (which is expected to be concluded in January 2021) will lay out the roadmap for the demise of all LIBOR determinations.
The announcements also mean that a significant quantity of U.S. dollar LIBOR-based financings will have run off by June 30, 2023, thus reducing the remediation burden on financial institutions. It also means that the legislative initiatives to deal with tough legacy contracts in the United States, particularly the one in the New York legislature, will have more time to be possibly enacted into law.
As important as understanding what the move means is understanding what it does not mean. First, it does not mean that instruments can continue to be originated using U.S. dollar LIBOR until June 30, 2023. The use of U.S. dollar LIBOR for new loans is to cease by the end of 2021. In their coordinated announcements, the U.S. banking regulators stated that LIBOR originations should end as early as practicable, and in no event later than December 31, 2021, and that before then, any new U.S. dollar LIBOR-based contracts should use an alternative rate or contain hardwired fallback language.
That said, it does not mean that firms should slow their remediation of U.S. dollar LIBOR or other LIBOR-based contracts. Non-U.S. dollar LIBOR-referenced contracts will need to be addressed before the end of 2021 and whilst, assuming that the consultation does confirm the proposal that U.S. dollar LIBOR financings will have their reference rate available until mid-2023, it does not address those contracts with a maturity date beyond that. So, whilst the quantum of the contracts needing remediation may be reduced by these announcements, it does not mean that they have all disappeared. In addition, the reduction in regulatory pressure to have all LIBOR-based contracts remediated in 2021 may have been replaced by economic and commercial pressures. As 2021 progresses, the new non-LIBOR-referenced loans will start to appear in portfolios, causing them to behave differently as the mix of LIBOR and non-LIBOR credits change over the course of the next 19 months. Similarly, the changeover to risk-free rates in the derivatives markets will result in the hedging of these mixed portfolios becoming more challenging and dynamic with the passage of time, particularly as liquidity drains from the LIBOR swap market.
Finally, a legislative solution for tough legacy contracts is neither a panacea for all tough legacy contracts nor a substitute for remediation; market participants have not been given a reprieve or even a breather – just a helping hand in reducing the pile of contracts to be remediated and a potential means of mitigating the adverse consequences of the intractable problematic ones.
Client Alert 2020-614
