The Alternative Reference Rates Committee today issued consultations on draft fallback language for bilateral business loans and securitizations that reference the U.S. dollar London Interbank Offer Rate. With Libor’s future beyond 2021 uncertain, the ARRC — a group of private-sector market participants and public agencies convened by the Federal Reserve — is developing plans to facilitate the transition to its recommended alternative rate, the Secured Overnight Financing Rate.
For bilateral business loans — a type of loan issued by almost every U.S. bank that makes commercial loans — the ARRC proposed two approaches to fallback language. One would provide a streamlined amendment mechanism to negotiate a replacement benchmark in the future; the other would be a “hardwired approach” that would replace Libor with a version of SOFR, providing more upfront clarity. Each approach includes proposed trigger events related to Libor cessation and a proposed mechanism for implementing a replacement rate and setting a spread — a key element as SOFR is likely to be lower than Libor and may behave differently in certain circumstances.
While many securitizations may fall back to a fixed rate based on the last published value of Libor should the benchmark no longer be available, the approach to fallback language for securitization is intended to replace Libor with a “more economically appropriate replacement rate and spread adjustment.” It involves clear triggers, rates and spread adjustments with some flexibility in the rate waterfall.
“The risks associated with Libor publication ceasing or changing are clear, so it is critical that we continue to prepare for this eventuality,” said ARRC Chairman Sandra O’Connor, who is chief regulatory affairs officer at JPMorgan Chase. “A crucial part of this preparation is to stop adding to the associated financial stability risks, by developing and implementing robust contract language for products referencing Libor.” Earlier this fall, the ARRC issued consultations on fallback language for floating-rate notes and syndicated business loans. Feedback on the two new consultations is due by Feb. 5. For more information, contact ABA’s Hu Benton.