May 4, 2020 |
Despite the ongoing coronavirus pandemic (COVID-19), the United Kingdom’s Financial Conduct Authority (FCA) reiterated that the London Interbank Offered Rate (LIBOR) will still not be available as a reference rate after the end of 2021. Accordingly, your organization must continue completing the substantial task of transitioning all LIBOR-linked contracts to an alternate rate no later than December 31, 2021, and, if applicable, to disclose all material information related thereto in your United States Securities and Exchange Commission (SEC) filings.
In July 2017, the FCA announced that banks would no longer be compelled to submit quotes in support of LIBOR after the end of 2021. Without the compulsion for banks to submit quotes, LIBOR will cease to be representative of the rates used between banks on the London interbank market, effectively setting a sunset date for the use of LIBOR in loan, mortgage and derivative contracts.
LIBOR is used in a myriad of financial transactions. This is evidenced by an analysis of the estimated scope of contracts referencing LIBOR from Factor Partners released on April 28th, which showed, among other things, the significant volume of contracts which are tied to LIBOR but do not contemplate the unavailability of LIBOR, such as transitioning to a successor rate. With knowledge of the transition away from LIBOR and the understanding of how pervasive LIBOR is, finding an acceptable alternate rate has been a priority for many organizations. Yet, as organizations try to work through the difficulties of transitioning away from LIBOR, COVID-19 presented a distraction. Requests poured in from market participants to delay or to make any sort of accommodation in light of the pandemic. In response, on April 29th, the FCA released commentary on the effect COVID-19 would have on the LIBOR transition, providing an accommodation to FCA-regulated institutions but not extending the sunset date for LIBOR.
Based on the analysis from Factor Partners and the FCA’s commentary on the LIBOR transition, market participants should consider the following key takeaways:
1. Gather LIBOR Contracts. If your organization has not already done so, you should compile and organize your contract database as soon as possible to determine which contracts reference LIBOR. The SEC released a statement in July 2019 urging organizations to be proactive on the transition, citing the “significant work” that remained. The analysis released by Factor Partners demonstrates exactly how significant: more than 100 million contracts use LIBOR as the reference rate which represent an estimated notional value of more than $400 trillion.
2. Review Impact. After identifying which contracts reference LIBOR, your organization must determine the effects of the discontinuation of LIBOR and whether the terms of the contract provide for any fallbacks in the event LIBOR is no longer available. According to the analysis released by Factor Partners, more than 40% of contracts do not specifically address the unavailability of LIBOR, and of contracts which include “fallback language”, as many as 50% would default to a fixed rate. Accordingly, on a contract-by-contract basis, your organization should:
• Determine whether the contract extends beyond December 31, 2021 (e.g., a loan maturing in 2022 or later).
• If so, determine whether the contract provides fallback language in the event of the unavailability of LIBOR (e.g., if LIBOR is unavailable, the applicable interest rate is . . .). If your contract does not contain fallback language, consider the nature of your relationship with the counterparty and whether you should involve legal counsel in amending the terms.
• If so, assess the fallback language: What is the fallback rate? Is it predetermined (such as the Secured Overnight Financing Rate (SOFR))? Is it solely determinable by the counterparty? Is to be agreed upon between the parties in good faith? Is it tied to market norms (e.g., “the reference rate for comparable transactions in the marketplace generally”)? Depending on your answers to the questions above, consider the nature of your relationship with the counterparty and whether you should involve legal counsel to remediate the terms.
3. Disclose. For public companies, current events likely altered your approach to upcoming SEC filings. However, it is notable that the LIBOR transition continues to be addressed in the midst of COVID-19, underscoring the importance to regulators. In the flurry of new COVID-19 disclosures, it is important to continue to address LIBOR transition if material. Such disclosures should include the status of efforts-to-date (including any challenges presented by COVID-19), significant matters yet to be addressed (including whether COVID-19 will adversely affect your ability to address these matters), and material exposures even in instances where the company does not know or cannot yet know the expected impact of the discontinuation or transition from LIBOR, all using qualitative and quantitative disclosures. Depending on materiality, these implications are wide-reaching and may involve discussion in risk factors, MD&A, board risk oversight, and financial statements
4. Looking Ahead. Market participants sought delays and accommodations, and, in light of COVID-19, the FCA recognized the difficulty presented by the current timeline and granted some reprieve in the form of a six-month extension (until March 31, 2021) for FCA-regulated institutions to issue LIBOR-linked contracts that expire after the end of 2021 (any such contracts must include “clear contractual arrangements” to facilitate conversion to an alternate rate through “pre-agreed conversion terms or an agreed process for renegotiation”). However, the FCA maintained as a central assumption in its commentary that LIBOR cannot be relied upon after the end of 2021. As of the April 29th release, there is no change in the timeline. Regardless of COVID-19, your organization must move forward with the mindset that LIBOR will not be available as a reference rate in just 17 months’ time.
• J. Bradley Boericke, Partner Pepper Hamilton
• Hazen H. Dempster, Partner, Troutman Sanders
• Deborah J. Enea, Partner, Pepper Hamilton
• David I. Meyers, Partner, Troutman Sanders
• Justin A. Wood, Partner, Troutman Sanders
• Cot Eversole, Associate, Troutman Sanders
• Jonathan D. Hammond, Associate, Pepper Hamilton
• Frank Montes de Oca, Associate, Troutman Sanders
Compliments of Pepper Hamilton – a member of the EACCNY.