Governor Cuomo’s 2022 budget proposal includes highly-anticipated legislation to facilitate the transition away from LIBOR for certain legacy contracts and provide a legal safe harbor for rate replacement.
SFA responded to IBA’s ICE LIBOR Consultation on Potential LIBOR Cessation. We support the proposed revision to the cessation timeline that extends the publication for widely-used USD LIBOR settings through June 30, 2023.
Under SFA and Market Participant Leadership, ARRC Securitization Working Group Publishes Options for Using SOFR in New ABS, MBS, and CMBS Products
As co-chairs of the ARRC SWG, SFA has an instrumental role in helping to enable a smooth transition and, most recently, identifying the key considerations relevant to developing new issuance of securitized products based on SOFR.
SFA is committed to leading the effort on the LIBOR transition within structured finance by engaging with members on all current policy and regulatory developments. SFA has created a presentation which outlines the current approaches for LIBOR benchmark replacement that market participants are considering in order to address and effectuate the LIBOR transition.
Our industry is keenly focused on LIBOR-based consumer and business loans and fixed income bonds currently outstanding: $3.4 trillion of business loans, $1.8 trillion of floating-rate notes and bonds, another $1.8 trillion of securitizations, and $1.3 trillion of consumer loans held by about four million individual retail consumers, including around $1.2 trillion of residential mortgage loans – to support an orderly, transparent and fair transition for all parties including the retail & institutional investors as well as the consumers and businesses.
The London Interbank Offering Rate (LIBOR) is going away soon, most likely at the end of 2021 when its regulator, the U.K.’s Financial Conduct Authority, stops compelling banks to submit the quotes from which it is derived. Why is one of the most important financial benchmarks, one that underpins nearly $400 trillion in financial contracts globally and $200 trillion in the U.S., on the way out? The 2008 LIBOR fixing scandal and subsequent lawsuits cast a long shadow on its use. But, perhaps more importantly, financial regulators’ growing concern that LIBOR’s lack of robustness, namely the insufficient number of real transactions that underlie the calculation of the rate, meant it was time to identify a new key benchmark rate.
Regulators and many private sector participants have been working hard to stem the tide of new LIBOR contracts that don’t have rigorous “fallback” language; i.e., language that would allow for a smoother transition from LIBOR to SOFR. The Alternative Reference Rates Committee (ARRC), a group of private-market participants convened by the Federal Reserve Board and the New York Fed to help ensure a successful transition from USD LIBOR to SOFR, has been at work since 2014 to try to ensure the move away from LIBOR is as seamless as possible. On May 31, 2019, the ARRC published its recommended fallback language for securitizations.
The industry is also focused on LIBOR-based loans and bonds currently outstanding: $3.4 trillion of business loans, $1.8 trillion of floating-rate notes and bonds, another $1.8 trillion of securitizations, and $1.3 trillion of consumer loans held by about four million individual retail consumers, including around $1.2 trillion of residential mortgage loans.
The Structured Finance Association is helping to lead the effort on developing new fallback language and untangling the legacy contract knot. The Association is engaged via our LIBOR Task Force and as a member of the ARRC. The Association also co-chairs the ARRC’s Securitization Working Group, which has published important policy guidance on this issue: please see the ARRC’s Securitization Consultation and Webinar.
To avert the coming LIBOR disaster, the finance industry needs to do several things:
- Include robust fallback language in all new LIBOR transactions, specifying what rate to use when LIBOR goes away. Otherwise, the number of financial contracts with weak or no LIBOR replacement language will keep growing.
- Amend legacy business loan contracts to specify a replacement rate. This can be done if the two sides simply agree how things should move forward.
- Make it possible for bondholders to communicate with each other so they, too, can collectively amend their contracts. Because of the way market infrastructure is set up now, it is impossible for investors holding the same security to communicate with one another, or communicate with the company who issued the securities, but technology could be used to change that.
Other larger-scale solutions must be weighed, and quickly. ARRC has considered approaching the New York State legislature to ask that it create a safe harbor interest rate for LIBOR-based contracts. And some key industry participants, including a significant and growing number of cash investors, are advocating for the continued production of LIBOR, or at least the creation of a synthetic LIBOR with SOFR as the key underlying component, to be used in legacy deals until they mature.
At the end of 2021, estimates put legacy LIBOR securities at approximately $2.4 trillion and business and consumer loans at roughly $1 trillion.
The Federal Reserve has been publishing overnight SOFR since April 2, 2018.
In order to help explain how market participants can use SOFR in cash products, the ARRC released A User’s Guide to SOFR. This paper addresses a range of topics, including differences between using simple or compound averages of SOFR and differences between calculating payments using in arrears or in advance conventions.
Spread Adjustment Methodologies for Fallbacks in Cash Products (June 30, 2020)
ICE LIBOR Information from LIBOR’s Administrator IBA
New York state plays a significant role because many securities products that reference LIBOR are governed by New York law and do not contain robust fallback language directing definitive actions if LIBOR ceases to exist. State legislation promoted by the ARRC will provide clarity and promote financial stability as market participants prepare for LIBOR to be discontinued.
Federal legislation is an important accompaniment to the New York State legislation as many contracts are governed by laws outside of New York.
ARRC-Proposed NYS LIBOR Legislation (December 4, 2020)
New York State Senate Bill S9070
SFA, Joint Letter Urging NYS Leaders to Consider ARRC LIBOR Legislation Proposal (December 16, 2020)
Key U.K. Policymakers
The Financial Conduct Authority (FCA) regulates the financial services industry in the U.K. Its role includes protecting consumers, keeping the industry stable, and promoting healthy competition between financial service providers. The FCA has regulated LIBOR since 2013.
Benchmarks Regulation – proposed new powers – U.K. parliament announced future legislation to amend the Benchmarks Regulation to give FCA enhanced powers (December 4, 2020)
FCA considerations when exercising powers (November 30, 2020)
“SFA has taken a leadership role in our market to facilitate LIBOR transition by bringing industry participants together to identify key issues and develop solutions.”
- Bob Behal Principal, Vanguard Group
Libor Replacements: Transitioning from Theory to Reality