The transition away from the London Interbank Offered Rate (LIBOR) has been in the works for many years, but a clear endgame for LIBOR has now been established. In November 2020, the Intercontinental Exchange (ICE) Benchmark Administration (IBA)—the administrator of LIBOR—announced an adjusted transition calendar. Publication of 1-week and 2-month LIBOR will cease as of Dec. 31, 2021, and publication of overnight, 1-month, 3-month, 6-month, and 12-month LIBOR will cease as of June 30, 2023 (although publication of the 1-month, 3-month, and 6-month U.S. dollar settings may be extended, as described in the “Key Dates in LIBOR Transition” below).
|
Key Dates in LIBOR Transition: March 5, 2021: The fallback spread adjustment published by Bloomberg became fixed for all U.S. dollar LIBOR settings. Data on fallback rates can be accessed on Bloomberg Terminals with the keystrokes FBAK <GO> and a click on USD LIBOR. December 31, 2021: Publication of 1-week and 2-month LIBOR ceases. June 30, 2023: Publication of remaining LIBOR tenors ceases (overnight, 1-month, 3-month, 6-month, and 12-month), although the Financial Conduct Authority (FCA) may continue publication on a synthetic basis of the 1-month, 3-month, and 6-month U.S. dollar LIBOR settings if views and evidence from U.S. authorities and other stakeholders merit extension of the publication deadline.] |
Why is the use of LIBOR ending?
The use of LIBOR as a reference rate is ending because the market for short-term unsecured lending to banks—the market on which LIBOR is based—has become much diminished in recent years. Because the underlying market for LIBOR has grown so small, the rate increasingly is based on expert judgment, not data derived from actual transactions. The result, as summarized by Andrew Bailey, governor of the Bank of England, is that LIBOR “can no longer claim to accurately reflect the marginal cost of funds for banks, nor to provide end users with confidence their interest payments are directly linked to those costs.”[1]
What alternative reference rates will replace LIBOR?
In 2014, the Federal Reserve Board and the Federal Reserve Bank of New York jointly convened the Alternative Reference Rates Committee (ARRC) to identify risk-free alternative reference rates for USD LIBOR. In 2017, the ARRC identified the Secured Overnight Financing Rate (SOFR) as its recommended alternative reference rate. SOFR is published daily by the New York Fed and is based on overnight transactions secured by U.S. Treasury securities.
For bonds and loans. While the International Swaps and Derivatives Association (ISDA) has established a protocol for swaps and derivatives, as discussed below, changes to contracts for bonds and loans (i.e., cash product contracts) will need to be individually negotiated between the health system and the bank providers. ARRC has developed recommended fallback language for market participants’ voluntary use in contracts that reference USD LIBOR.[2] The recommended fallback language uses spread-adjusted SOFR rates that are equivalent to the ISDA protocol methodology and will be published by Refinitiv.[3]
For swaps and derivatives. In October 2020, ISDA published standardized documentation and a protocol to revise fallback language in the event that LIBOR ceases to be published. The ISDA protocol uses an adjusted SOFR rate and spread tied to the various USD LIBOR tenors as the replacement rate when publication of LIBOR ceases; the spread adjustment became fixed as of March 5, 2021. Bloomberg has been selected to publish the fallback rates: real-time data on fallback rates can be accessed on Bloomberg Terminals with the keystrokes FBAK <GO> and a click on USD LIBOR. For example, on March 4, 2021, the fallback rate on Bloomberg for 1-month LIBOR was 0.148%. This compares to the actual 1-month LIBOR of 0.104% or a difference of 4.4 basis points. Therefore, if a health system had a 70% of 1-month LIBOR fixed pay swap, they would receive an incremental 3.1 basis points if the fallback rate was employed.
Adherence to the ISDA protocol is available now and applies only to swap and derivative contracts. However, health systems are not subject to a specific deadline for adherence. Moreover, parties are free to negotiate their own alternative replacement rate (e.g., Fed Funds, SIFMA, SOFR) if they choose not to adhere to the ISDA protocol or if they are parties to contracts and agreements not covered by the protocol, such as loans and bonds, as discussed above.
What other issues must be resolved?
Successful transition away from LIBOR will require additional action on several fronts, including the following:
- Legislative change. While the ISDA protocol process is a clear solution for swaps, there is no equivalent universal solution for non-swap contracts such as loans and bonds. The ARRC has proposed legislation in New York, which is named as the governing jurisdiction in many of the affected loan and bond documents, which would impose a benchmark replacement rate on documents that cannot be amended or that have inadequate fallback language. The proposed legislation would not override existing fallback provisions that effectively reference a replacement rate, such as SOFR, and parties could mutually agree that the imposed rate does not apply to their document.[4]
- New contracts. The IBA’s extension of the publication cessation date for most LIBOR tenors to June 30, 2023, is intended in part to allow most legacy LIBOR contracts to mature before publication of LIBOR ceases. For new contracts executed before LIBOR publication ceases, federal agencies are encouraging parties to stop using LIBOR as a reference rate as soon as possible, and in most cases by the end of 2021. New contracts that still use LIBOR as the reference rate should include robust fallback language that clearly specifies an alternative reference rate.[5]
How should health systems prepare?
Health systems should assume that LIBOR transition will proceed according to the calendar outlined in the IBA’s November update, and engage in an ongoing process to:
- Assess the current state. Review the existing portfolio for LIBOR instruments and language and take inventory of LIBOR exposure in all borrowings and commitments, including swaps, debt, loans, leases, and potentially investments.
- Monitor updates. Closely monitor the transition away from LIBOR and understand the alternatives, then develop procedures and steps for implementing them. Also monitor the financial press for updates to timing of the transition, including potential delays or new anticipated deadlines.
- Prepare for the transition. Develop a calendar to review and update documents based on the updated transition dates; insert fallback language with a clearly specified alternative reference rate as documents are renewed, refinanced, or amended.
If you have any questions or would like to discuss how to prepare for the transition from LIBOR, please contact Steve Sohn by email (ssohn@kaufmanhall.com) or phone at (224) 724-3474.
[1] Bailey, A.: “Libor: Entering the Endgame.” Bloomberg Webinar, July 13, 2020. https://www.bankofengland.co.uk/speech/2020/andrew-bailey-speech-as-part-webinar-hosted-by-the-boe-and-the-frb-of-ny-libor-entering-the-endgame
[2] Federal Reserve Bank of New York website: Fallback Contract Language https://www.newyorkfed.org/arrc/fallbacks-contract-language
[3] Alternative Reference Rates Committee: “ARRC Announces Refinitiv as Publisher of Its Spread Adjustment Rates for Cash Products.” Press release, March 17, 2021.
[4] Cuillerier, I., Hammond, A., Ridley, D., Silnicki, G.: “Proposed NY Law Targets LIBOR Fallback Problems.” White & Case, Nov. 10, 2020. https://www.whitecase.com/publications/alert/proposed-ny-law-targets-libor-fallback-problems
[5] U.S. Securities and Exchange Commission: “Office of Municipal Securities Staff Statement on LIBOR Transition in the Municipal Securities Market.” Jan. 28, 2021.
