LIBOR Transition: What happens now?

Introduction

Many loan market participants, including finance parties and borrowers, have spent considerable resources in preparing for the LIBOR D-Day that was 31 December 2021. Now that the much-anticipated deadline has passed, the questions in many minds are: what happens now and when can we announce a V-Day?

Recap

By way of a brief recap and as neatly summarised by the Financial Conduct Authority (FCA) in the UK, since 1 January 2022, 24 of the then 35 LIBOR settings which related to specific currencies and time periods, are no longer available.

Of the remaining LIBOR settings, the FCA has confirmed that:

• 6 Sterling and Yen LIBOR settings, namely the 1, 3 and 6 months tenors for both currencies, will continue at least till the end of 2022 in the form of “Synthetic LIBOR”. We explain this in further detail below; and
• 5 USD LIBOR settings, namely the Overnight and the 1, 3, 6 and 12 months tenors for USD, will continue to be calculated using the usual method (i.e. through submissions made by LIBOR panel banks) until 30 June 2023.

We refer to these as the Continuing LIBOR Settings.

Unlike the previous form of LIBOR settings (which were calculated by reliance on submissions from panel banks), Synthetic LIBOR will be calculated based on risk-free rates (RFRs). More specifically, the Synthetic LIBOR settings will be calculated based on the applicable term RFR (namely, the Term SONIA Reference Rate as provided by ICE Benchmark Administration for Sterling and Tokyo Term RFR as provided by Quick Benchmarks Inc. for Yen) plus the relevant ISDA Spread Adjustment as provided by Bloomberg Index Services Limited for the particular setting. For completeness, the FCA has permitted uses of Synthetic LIBOR only in legacy contracts, other than cleared derivatives.

The answer to the question “what happens now” depends on the contract in question (where “contract” includes any facility agreement, derivatives contract or other arrangement under which interest or a fee or other payment is calculated by reference to a LIBOR benchmark). In particular, we have identified contracts as falling into three main categories:

1. Contracts which have been amended to incorporate rate switch provisions.
2. Contracts which have not been amended to incorporate any rate switch provisions.
3. New contracts.

Amended contracts

Some contracts have been amended to include rate switch provisions. These provisions would typically have the effect of automatically replacing the existing references to the relevant LIBOR as the benchmark rate with the nominated alternative reference rate on the occurrence of the earlier of the following:

• a benchmark cessation event; or
• the backstop rate switch date, which we would expect to be no later than 31 December 2021 (unless the relevant LIBOR was a Continuing LIBOR Setting).

Subject to the exact drafting of the contract and unless the relevant LIBOR was a Continuing LIBOR Setting, the passing of 2021 should have triggered a Benchmark Cessation Event or would have meant that the backstop rate switch date has now passed. This means that the benchmark rate would automatically switch from the relevant LIBOR to the nominated alternative reference rate.

Contracts which have not been amended

Some contracts have not been amended by the parties to include rate switch provisions.

If the contract relates to a Continuing LIBOR Setting, the methodology for determining the interest rate should remain unaffected until the earlier of:

• the date on which the relevant Continuing LIBOR Setting would cease to be published; or
• the date on which the parties amend the contract to replace the benchmark rate with an alternative reference rate.

In saying that, the FCA is clear in its messaging that contract parties should not be relying on Synthetic LIBOR as a permanent solution. Instead parties should actively seek to amend their contracts to include appropriate rate switch provisions. In other words, if the contract term is intended to be extended beyond the cessation date for the relevant Continuing LIBOR Setting, the contract parties should seek to amend the contract prior to that date.

On the other hand, if the contract relates to a LIBOR which isn’t a Continuing LIBOR Setting, the interest rate should/must be calculated based on the existing fallback provisions within the contract (if any). If the existing contract terms do not contemplate a fallback rate or the provisions that trigger the fallback rate applying are not suitably drafted (so-called ‘tough legacy’ contracts), the issue would be more serious and parties should consider whether they are still able to transact (including to provide financing) based on the existing contract terms as there would be a risk that the interest payable may not be able to be calculated in accordance with agreed terms.

New contracts

It has been made clear by various regulators that there must be no new uses of LIBOR after 2021, subject to some limited exceptions including risk management for pre-existing positions. This means that no new contracts should reference any Continuing LIBOR Settings and instead any new contracts entered into must reference alternative reference rates, such as RFRs.

Other IBORs

During the course of 2021, other countries’ industry working groups presiding over benchmark transition for their currencies have provided guidance on the intended cessation of other IBORs. For instance, the Singapore Steering Committee overseeing the transition from SOR (Singapore Offered Rate) to the preferred SGD RFR, SORA, had recommended that usage of SOR in new loans (maturing after 31 December 2021) should cease by 30 April 2021. It has further recommended substantial reductions in banks’ SOR corporate exposures by 31 December 2022. SOR, which relies on USD LIBOR in its computation, will similarly be discontinued immediately after 30 June 2023.

Contract parties should therefore continue to take note of recommendations, announcements or public statements by relevant working groups and regulators overseeing benchmark transition for specific currencies, to ready themselves for smooth transition.

Conclusion

Although many loan market participants have successfully transitioned prior to the end of 2021, many other participants still have work ahead of them - either to transition away from a Continuing LIBOR Setting prior to those relevant cessation dates or to familiarise themselves with the alternative reference rates.

As to the question of V-Day, the target date for complete cessation of LIBOR references remains 30 June 2023 subject to any future change in the regulatory approach. The FCA has not ruled out requiring synthetic USD LIBOR settings after 30 June 2023 but has warned market participants not to rely on this possibility.

Regardless of when V-Day will finally be, contract parties should forge ahead and transition any remaining references to LIBOR as soon as possible.

If you have any questions in relation to the above, please reach out to Nuncio D’Angelo, Phil Charlton or Tina Teo.