LIBOR—the London Inter-bank Offered Rate—has been a key interest rate benchmark in commercial lending since the 1980s. LIBOR is derived from the interest rates at which major banks would lend to each other on a short-term unsecured basis. In the aftermath of the Great Recession, however, concerns surfaced over possible manipulation of the process for setting LIBOR, as well as whether the inter-bank lending market continued to be sufficiently robust. As a result, some lenders, regulators, and other participants concluded that LIBOR was not only potentially unreliable, but could even become unavailable, particularly in times of economic stress. As SEC Chair Gary Gensler recently put it, LIBOR had become “something akin to an inverted pyramid” where a massive financial market rested on very few underlying transactions.

In response to those issues and to address the risk of market disruptions, in 2014 the Federal Reserve convened The Alternative Reference Rates Committee (ARRC), which consists of private-sector stakeholders and public-sector entities, including banking and financial regulators. The ARRC’s purpose is to “identify a set of alternative reference interest rates that are more firmly based on transactions from a robust underlying market and that comply with emerging standards, such as the International Organization of Securities Commissions’ Principles for Financial Benchmarks, and to identify an adoption plan with means to facilitate the acceptance and use of these alternative reference rates.”

Early in this process, the Secured Overnight Financing Rate (SOFR) surfaced as the most likely successor to USD LIBOR. SOFR is a “risk free” rate based on the interest rates for overnight repurchase transactions secured by U.S. Government debt and has the advantage of reflecting a deep, robust, and historically active market. With the probable successor benchmark identified, the next priority was to develop the infrastructure for the conversion from USD LIBOR to SOFR, including: (1) the contractual provisions by which a benchmark transition will be triggered and then accomplished; (2) determination of the manner in which SOFR will be calculated and used in place of USD LIBOR; and (3) recommended best practices for the transition.

The primary players in the transition—the ARRC and various industry organizations, such as the Loan Syndications and Trading Association (LSTA) and the International Swap Dealers Association (ISDA)--have developed and published contract language for the transition from LIBOR to SOFR in lending and derivative markets. Various regulatory authorities have also made announcements regarding the end of LIBOR and the transition.

Based on that background, here are some of the key developments and the emerging picture:

• In anticipation of the transition, most lenders have adopted some form of contract language for loan documents to address the events that trigger the switch to a new benchmark, the selection of the replacement benchmark, and sundry technical and mechanical issues. Although there are several different approaches, the trend in the loan market has been toward the so-called “hardwired language” recommended by the ARRC. This approach sets an automatic process by which the transition to SOFR will be made on outstanding loans once LIBOR ceases or when the parties elect a pre-agreed “early opt-in”. Within the typical hardwired language is a waterfall of possible rates (based on availability) to replace USD LIBOR. Although this concept continues to develop, the common order of replacement is (1) Term SOFR (a forward-looking rate with interest periods similar to LIBOR, which has not yet been adopted by the ARRC) plus a spread adjustment; (2) some form of daily SOFR (which may also be stated as compounded over the relevant interest period or subject to other variations) plus a spread adjustment; and (3) a rate agreed upon through a defined amendment process with an eye to current and emerging market conventions.
• On March 5, 2021, the administrator of LIBOR (the ICE Benchmark Administration) announced the future LIBOR cessation. That announcement (with the corresponding announcement by ICE’s regulator, the UK Financial Conduct Authority) triggered both (1) the announcement of the spread adjustments to be made to SOFR to more nearly equalize it to historical USD LIBOR and (2) the dates by which various LIBOR settings would cease to be published. In response, the ARRC has also published streamlined hardwired language, which incorporates the spread adjustments and makes other updates.
• Based on those announcements, it now appears that publication of one-week and two-month USD LIBOR will end on December 31, 2021; all other USD LIBOR settings (overnight/spot, one-month, three-month, six-month and 12-month) will cease publication on June 30, 2023; and LIBOR settings in other currencies will also end by December 31, 2021.
• The ARRC-recommended best practices for lenders suggest that new LIBOR loan originations should end by June 30, 2021. More importantly, many U.S. banking and other financial industry regulators have made numerous public statements strongly encouraging banks and other institutions to cease entering into new contracts that use USD LIBOR by December 31, 2021, and suggesting that continued LIBOR originations after that date may pose safety and soundness concerns.
• Even though signs have pointed to SOFR as the replacement benchmark, there are lingering concerns in the loan markets driven in part by the “risk free” and secured nature of the rate, the lack of an adopted term/forward-looking rate, and a desire to have a rate more closely tied to actual bank cost of funds. As a result, there has been growing interest in so-called “credit sensitive” replacement rates. These are rate indices that consider bank credit risk/cost of funds (for example, CD rates, bank deposits, and corporate bond rates) and, therefore, are arguably more like LIBOR. The leading candidates are the Bloomberg Short Term Bank Yield Index (BSBY); the ICE Bank Yield Index; the IHS Markit Credit Rate; and Ameribor. As evidence of this development, a recent syndicated credit facility included a BSBY rate option. Nevertheless, concerns remain whether these rates reflect a sufficiently broad and deep market or risk repeating the “inverted pyramid” problem of LIBOR.
• Based on recent statements, it appears that the ARRC expects soon to adopt a Term SOFR that would allow various forward-looking tenors and thereby address one of the criticisms of SOFR. Reflecting the building momentum towards Term SOFR, the ARRC recently announced selection of CME Group as the recommended administrator of the rate.

What does this mean for individual lenders and borrowers? The answer depends in large part on where these players fit into the process. Possible scenarios include:

• New loans. For borrowers currently negotiating or contemplating new loans (including refinancings), most bank lenders either have or will soon cease to offer LIBOR as an option for these loans even though the benchmark will most likely continue to exist through mid-2023. Accordingly, in these transactions the focus should be on what new rate options will be available.
• Existing loans with LIBOR replacement provisions. This encompasses many “legacy” loans entered into (or amended) in the last 2-3 years, which likely include replacement provisions. These may include the ARRC “amendment” or “hardwired” approaches which contemplate replacement of LIBOR either with a bank-selected replacement or the pre-agreed waterfall or replacement options described above. Moreover, many lenders have not adopted the ARRC language verbatim or have bespoke replacement provisions. Accordingly, parties to these legacy transactions should review the applicable provisions carefully. For example, the triggers for replacement may vary and not all provisions in current use allow the continued access to LIBOR for these legacy contracts through the 2023 expected end of publication.
• Existing loans with “pre-ARRC” replacement language. This includes older “hard legacy” USD LIBOR loans that have not been previously amended to include a current version of the transition provisions. Even these loans will typically have some replacement language, but historically such provisions address temporary LIBOR unavailability/illegality as opposed to discontinuation of the benchmark. The replacement rate may also be a “prime” or “base” rate plus a credit spread, which may not be economically equivalent to LIBOR. Some limited relief for these hard legacy contracts has been made available legislatively—e.g., for agreements governed by New York law, recent legislation would impose the ARRC hardwired approach in the case of contracts that either do not have fallback provisions or provide of a fallback that would continue to be based on LIBOR. Similar legislation is also being considered in the U.S. Congress.

The above is intended only as a summary of the state of play in the commercial lending markets. There are numerous resources readily available to help better understand these issues, including the ARRC website: https://www.newyorkfed.org/arrc. Now is the time for all parties to understand what is coming and especially for borrowers to address how the transition will affect their credit facilities. Reflecting the growing inevitability of the transition, at the June 11, 2021 meeting of the U.S. Financial Stability Oversight Council, Fed Vice Chair Randal Quarles offered a “eulogy for LIBOR,” stating that “the deniers and the laggards are engaging in magical thinking” and that “there is no path forward for LIBOR after the end of this year.” Truly, the End is Nigh.