As SOFR Deadline Looms, FCA Proposes Extensions for 'Synthetic' Approach to Legacy USD LIBOR Contracts

On November 23, 2022, the United Kingdom Financial Conduct Authority (FCA) published its Consultation on 'Synthetic' US Dollar LIBOR (the Consultation), to strategically advance certain synthetic applications of USD LIBOR from June 30, 2023, until September 30, 2024. In this alert we help readers determine whether their USD LIBOR contracts will look to the Secured Overnight Financing Rate (SOFR) after June 30, 2023, or will look to synthetic USD LIBOR until September 30, 2024.

LIBOR—the benchmark rate used to set interest rates for commercial loans, mortgages, derivatives, and many other products—is being discontinued and was to be fully replaced in 2023 by SOFR, a risk-free rate designed to provide a more accurate cost of lending and borrowing. However, there remain trillions of dollars in legacy contracts based on LIBOR that cannot be easily transitioned. A “synthetic” USD LIBOR rate is designed to provide a temporary method to ease the transition of those “tough legacy” LIBOR contracts.

Per the Consultation, the FCA makes three recommendations, subjected to comment by January 6, 2023:

• To extend publication of USD LIBOR in 1, 3, and 6 month tenors until September 30, 2024;
• To report synthetic USD LIBOR for the 1, 3, and 6 month tenors after June 30, 2023, as unrepresentative; and
• To not prohibit usage of synthetic USD LIBOR in contracts that reference United States laws.

The synthetic basis is proposed to be a combination of Chicago Mercantile Exchange Term SOFR plus the following spread adjustments:

• 11.448 basis points for one-month tenor.
• 26.161 basis points for three-month tenor.
• 42.826 basis points for six-month tenor.

Assuming the Consultation results in an FCA decision as proposed, here are the situations where June 30, 2023, will be the last day of USD LIBOR:

• The contract contains adequate conversion provisions to SOFR triggered by not only the discontinuation of LIBOR but also by an announcement of unrepresentativeness (sometimes called a pre-cessation trigger); or
• The contract is subject to the Adjustable Interest Rate (LIBOR) Act.

Conversely, there are situations where September 30, 2024, will be the last day of USD LIBOR:

• The contract contains conversion provisions that do not include a pre-cessation trigger (including contracts that fall back to a non-LIBOR rate such as prime in the event that publication of LIBOR is discontinued);
  
• A USD LIBOR contract whose governing law is a non-US law (i.e. that is not subject to the Adjustable Interest Rate (LIBOR) Act);
  
• A contract under which the determining person elects to rely on synthetic USD LIBOR.

Derivatives that incorporate the provisions of the ISDA IBOR 2020 Protocol or 2021 definitions should contain adequate conversion triggers that include pre-cessation language. Derivatives that do not incorporate the provisions of the ISDA IBOR 2020 Protocol or the 2021 definitions should be subject to the Adjustable Interest Rate (LIBOR) Act. As a result, most derivatives should not be impacted by the Consultation or rely on synthetic USD LIBOR.

Following are some examples of pre-cessation triggers from the Alternative Reference Rate Committee (AARC)'s suggested conversion, or fallback, language:

• For Loans—On the earlier of (i) the date that all Available Tenors of USD LIBOR have either permanently or indefinitely ceased to be provided by IBA or have been announced by the FCA pursuant to public statement or publication of information to be no longer representative and (ii) the Early Opt-in Effective Date, if the then-current Benchmark is USD LIBOR, the Benchmark Replacement will replace such Benchmark for all purposes hereunder and under any Loan Document in respect of any setting of such Benchmark on such day and all subsequent settings without any amendment to, or further action or consent of any other party to this Agreement or any other Loan Document.
• For Floating Rate Notes—“Benchmark Transition Event” means the occurrence of one or more of the following events with respect to the then-current Benchmark: … a public statement or publication of information by the regulatory supervisor for the administrator of the Benchmark announcing that the Benchmark is no longer representative.

Ballard Spahr represents clients across public and private markets and throughout the capital stack in a wide range of complex debt and equity transactions. With more than 120 lawyers nationwide—and teams focused on specific industry sectors, project types, and deal structures—Ballard Spahr’s Finance Department has a long history of efficiently closing deals and delivering value to our clients as we work to achieve their business goals. Please contact us if you have questions about the LIBOR to SOFR transition.

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