Feature

The Death of LIBOR and the Afterlife

By Gary A. Goodman and Alice F. Yurke

In July 2017, Andrew Bailey, chief executive officer of the UK Financial Conduct Authority (FCA), announced that the FCA would no longer require panel banks to make London Inter-Bank Offered Rate (LIBOR) submissions after the end of 2021. Since the early 1980s, LIBOR and other interbank-offered rates have acted as the reference rates for trillions of dollars in real-estate-secured and other loans, bonds, and securitizations and deposits and derivatives notional. This article provides an overview of LIBOR’s historical importance in the financial markets and describes certain challenges in transitioning to a new risk-free rate.

London's Big Ben

London's Big Ben

Skyline of London

A Brief History of LIBOR

LIBOR was developed and launched in the mid-1980s by the British Bankers Association. It is used by the real estate industry as the index rate in many floating rate loans. LIBOR is derived from submissions by panel banks and represents the rate at which those banks could borrow funds in various currencies and tenors from other banks in London. In practice, LIBOR submissions have proven to be subject to manipulation and tampering, as evidenced by the rate-rigging scandal that came to light in 2012. Administration of LIBOR was shifted to the ICE (Intercontinental Exchange)Benchmark Administration (IBA) in 2014.

LIBOR Today

LIBOR is currently produced on a daily basis in five currencies: US dollar, Euro, British pound sterling, Japanese yen, and Swiss franc. Sixteen major money center banks are on the panel that contribute rates to USD LIBOR. The banks are based in various jurisdictions and all have operations in London. LIBOR is calculated in various tenors and maturity rates, including overnight, one week, one month, two months, three months, six months, and 12 months. IBA has taken significant steps to improve the production of LIBOR by establishing oversight, surveillance, and validation procedures designed to reduce the possibility of manipulation.

Advantages of LIBOR

LIBOR is forward-looking and is designed to predict a bank’s actual cost of funds over a given time period in the future corresponding to the relevant tenor. If LIBOR is accurate, then a bank can reasonably price loans on a forward basis by simply adding a margin reflecting the bank’s cost of operations and profit margin, as well as borrower risk. LIBOR as an index also gives the borrower certainty of payment. For example, in a loan with six-month LIBOR as an index, the rate will reset every six months, and the borrower will know its exact cost for the upcoming period. In contrast, if the borrower’s rate is based on an overnight index, its borrowing cost is far less certain.

Disadvantages of LIBOR

Panel banks have an understandable reluctance to contribute rates to support LIBOR, given the risk of future liability based on claims of manipulation, notwithstanding improved internal controls and procedures. After the credit crisis, the actual reliance by banks on the interbank lending market for funding operations has declined substantially. As a result, current submissions by panel banks are to a large extent based on “expert judgment,” or estimates of the rates the submitting banks would be charged, rather than actual or comparable transactions. LIBOR, therefore, suffers both from reputational concerns and from an absence of robust underlying market data and is disfavored by policy makers.

IOSCO Principles

In July 2013, the International Organization of Securities Commissions (IOSCO) issued its Principles for Financial Benchmarks (the Principles), following on the LIBOR rate-rigging scandal. The benchmarks discussed in the Principles are prices, estimates, rates, indices, or values that are: (1) made available to users, whether free of charge or for payment; (2) calculated periodically, entirely, or partially by the application of a formula or another method of calculation to, or an assessment of, the value of one or more underlying interests; and (3) used for reference. Reference purposes include one or more of the following: (a) determining the interest payable, or other sums due, under loan agreements or under other financial contracts or instruments; (b) determining the price at which a financial instrument may be bought, sold, traded, or redeemed or the value of a financial instrument; or (c) measuring the performance of a financial instrument. The Principles are designed to address conflicts of interest, promote internal controls, and improve governance and oversight. Principle 6 indicates that benchmark design should consider the “relative size of the underlying market in relation to the volume of trading in the market that references the benchmark.” Principle 7 recommends that a benchmark be “based on prices, rates, indices, or values that have been formed by the competitive forces of supply and demand” and “anchored by observable transactions entered into at arm’s length between buyers and sellers in the market.” Principle 8 provides a hierarchy for data inputs, ranking a submitter’s own concluded arms-length transactions first and expert judgment last. Policymakers and industry participants in various countries, including the United States, have been working towards the development of new benchmarks that follow the IOSCO principles.

The FCA

The FCA is the regulator that has the power to direct panel banks to continue to submit rates to IBA to help generate LIBOR, inasmuch as the rate submission activity takes place in London. In July 2017, FCA Chief Executive Officer Andrew Bailey asserted that “the absence of active underlying markets raises a serious question about the sustainability of LIBOR benchmarks that are based upon these markets.” Andrew Bailey, The Future of LIBOR (July 27, 2017) (speech at Bloomberg London), https://bit.ly/36OzdhT. This statement prompted the FCA to take the position that panel banks would no longer be compelled or encouraged by the FCA to submit rates in support of LIBOR, effective at the end of 2021.

Notwithstanding recognized improvements in the production of LIBOR, the FCA’s determination is based on the absence of an active substantial underlying market in inter-bank unsecured lending (see IOSCO Principle 6). This announcement does not mean that LIBOR will definitely cease to be produced at the end of 2021. Continued LIBOR after 2021, however, would be dependent on the willingness of a sufficient number of panel banks to voluntarily continue to submit bids.

A Visualization of Financial Stability & LIBOR

ARRC Implementation Plan

In November 2014, the Alternative Reference Rates Committee (ARRC) was convened by the Federal Reserve Board and the Federal Reserve Bank of New York (NY Fed) to consider new US dollar risk-free reference rates. ARRC members include a number of major banks and industry groups, and ARRC obtains input and participation from a broad range of market participants and US regulators. In June 2017, ARRC announced it had selected the secured overnight financing rate (SOFR) as the preferred alternative US dollar risk-free reference rate and as its preferred alternative to USD LIBOR. In March 2018, ARRC published the “Second Report,” its most authoritative and comprehensive publication to date regarding the transition away from LIBOR. ARRC’s Second Report outlines its Paced Transition Plan, which would result in a forward SOFR curve from which term SOFR rates could be derived. The timeline contemplates the following completion dates:

  • End of 2018: trading begins in futures and uncleared swaps referencing SOFR.
  • 2019 Q1: trading begins in cleared swaps that reference SOFR.
  • End of 2021: creation of term SOFR reference rate based on SOFR derivatives market, provided the market has developed enough to provide a robust rate.

About SOFR

In the United States, SOFR is the leading new alternative reference rate under development, produced by the Board of Governors of the NY Fed. SOFR is an overnight rate, calculated and published daily, based on an average of reported overnight repurchase transactions in US Treasury securities, captured from several sources that report actual transaction data to the NY Fed. The sources capture the vast majority of actual transactions of this type. The NY Fed commenced publication of SOFR in April 2018. SOFR meets the IOSCO criteria in that the underlying market (US Treasury repos) is extremely broad and robust, and there is very substantial actual reported transaction data available based on market transactions.

SOFR Attributes

SOFR underlying data are not limited to bank-to-bank lending but rather are based on transactions among participants in the broad US Treasury repo market, which may be banks, broker dealers, insurance companies, pension funds, private equity funds, corporations, and others. The data submitted to the NY Fed are almost all based on overnight transactions and do not contain data from which term rates could be derived. For SOFR to be used as a lending rate to replace LIBOR, term rates must be derived from SOFR.

SOFR is essentially a risk-free rate because the underlying transactions are fully secured by high quality liquid collateral. In contrast, LIBOR is an unsecured borrowing rate and includes a component that reflects the borrowing bank’s creditworthiness, especially as to longer tenors. Unlike LIBOR, SOFR is a backward-looking rate. Because of these differences, SOFR can be expected to perform differently from LIBOR.

SOFR Futures Trading

In May 2018, CME Group Inc. (CME) launched quarterly and monthly SOFR futures contracts, listed by CME and available for trading by CME clients. The quarterly contract references daily compound SOFR over a future three-month reference period. The reference periods end in March, June, September, and December and are available up to five years out. The monthly contract references average SOFR over a calendar month, and these contracts are available up to seven months out. It has recently been reported that there are now over 130 participants in the CME SOFR futures contract market, with average daily trading volume running in the range of $68 billion notional and open interest at $479 billion notional. Trading volume could be expected to increase significantly to the extent that market participants begin to incur financial obligations linked to SOFR and, therefore, require SOFR futures contracts for hedging purposes. At this time, it is not clear whether trading in SOFR futures will be robust enough to produce forward SOFR term reference rates that would meet IOSCO standards.

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Transition Risks

SOFR appears to be a very high quality, well-designed reference rate for new transactions. But as an index to replace LIBOR in existing contracts without causing material economic gain or loss to either party, SOFR has issues:

  • SOFR is a risk-free rate; it is unknown whether a market convention will develop to add a spread to SOFR to reflect the bank credit risk embedded in LIBOR.
  • SOFR is an overnight rate only; it is not known for certain that a term SOFR curve based on derivative trades will develop and will be accepted as a market convention.
  • Even if a term SOFR curve develops, under the ARRC timeline this will not be completed until the end of 2021, just when LIBOR would be phasing out, leaving no margin for error if there is a delay.

Will There Be a Term SOFR?

The Structured Finance Association and other industry groups have advocated that for the cash markets (including floating rate loans), there should be a true forward-looking term SOFR derived from overnight SOFR. Forward-looking term SOFR would predict SOFR over a future accrual period, based on market transaction inputs, and would be available at the beginning of the accrual period. It would be comparable to forward term LIBOR minus a credit component. However, the vast majority of LIBOR-based transactions that might convert to SOFR are derivatives, which reference an overnight index and do not require a forward-looking term index. For this reason, policymakers have discouraged use of a forward term replacement index for derivatives, and the International Swaps and Derivatives Association, Inc. (ISDA) Consultations more fully discussed below do not include a forward term SOFR. In line with this trend, and in light of concerns about the volume of SOFR futures trading, ARRC leadership has indicated that there can be no assurance that a forward-looking term SOFR will actually develop.

In Advance or in Arrears SOFR

Although SOFR itself is an overnight rate, SOFR could be derived over a given accrual period (e.g., 30 or 90 days) through a number of approaches. “In advance” means that the SOFR for a given accrual period is calculated at the start of the period but is based on overnight SOFR over the period ending on or about the start of the period. In other words, the observation period is the period before the accrual period. For example, if the accrual period is fourth quarter 2019, the rate is determined at the start of the accrual period but is based on actual overnight SOFR over third quarter 2019. Thus, the “in advance” approach is based on backward-looking or “stale” information but has the benefit of being known at the start of the accrual period. “In arrears” means SOFR for a given accrual period is calculated at the end of the period, based on overnight SOFR over the accrual period. In other words, the observation period is the same as the accrual period. For example, if the accrual period is fourth quarter 2019, the rate is determined at the end of the accrual period based on actual overnight SOFR during fourth quarter 2019. The “in arrears” approach is based on actual rate information during the accrual period but has the disadvantage of not being known at the start of the accrual period. When using the “in arrears” approach, the observation period may be pushed back by a few days, so that the rate can be calculated a few days before the end of the accrual period. The “in arrears” approach is favored by ISDA and may be suitable for corporate debt but is viewed as inappropriate for consumer debt.

Compounded or Average SOFR

“Compounded” means that the daily overnight SOFR rate is compounded on a daily basis over the observation period. This results in a slightly higher rate for the observation period because of the effects of compounding and is thought to, at least to some extent, convert SOFR from an overnight rate to a term rate. The overwhelming majority of derivatives market participants favor the compounded-in-arrears approach, which fits in well for overnight indexed swaps over a fixed contractual time period. However, market participants in the cash markets have indicated that the calculations for compounding could prove burdensome for those markets. An alternative to compounding would be to average overnight SOFR over the relevant observation period and add a margin to adjust the average overnight rate to a term rate. In the capital markets, a number of corporate debt issuances that reference SOFR have been made. Generally, these transactions use averaging (not compounding) in arrears.

Spread Adjustment

Because overnight SOFR is a risk-free rate, in contrast to all tenors of LIBOR, which include a bank credit component, when using SOFR as a replacement for LIBOR it may be desirable to add a spread adjustment in order to minimize any value transfer. Minimization of value transfer at the time of conversion is deemed desirable in order to avoid gains and losses, which may create tax and accounting issues for all parties. The spread adjustment would add on a factor to account for bank credit risk over the relevant accrual period. The spread adjustment also would take into account the difference in tenor between the tenor of LIBOR being replaced and the form of SOFR being applied. This difference is greatest with overnight SOFR and least with forward-looking term SOFR. Spread adjustment is not dynamic. It is a fixed amount that minimizes value transfer at the point of benchmark replacement.

ISDA Consultations

ISDA is planning to amend its 2006 Definitions so that its floating rate options provide new fallbacks that would replace LIBOR—and other inter-bank offered rates (IBORs) produced in other jurisdictions—in the event of a permanent discontinuation of LIBOR. ISDA published a multi-jurisdictional consultation in July 2018 for comment on proposed fallbacks for various IBORs (the 2018 ISDA Consultation). Under the 2018 ISDA Consultation, the fallbacks for each relevant IBOR would be triggered on the occurrence of:

  • A public statement by the IBOR administrator that it will cease publication of the benchmark, or
  • A public statement by the regulatory supervisor of the administrator, or other authorities with jurisdiction over the administrator, that the benchmark will cease to be provided.

In each case, the effective date of the conversion to the fallback will be the actual date of discontinuance of the relevant LIBOR. The 2018 ISDA Consultation requested comment on proposed fallbacks, including:

  • Spot overnight reference rate and convexity-adjusted overnight rate;
  • Compounded setting in arrears; and
  • Compounded setting in advance.

The 2018 ISDA Consultation also introduced three concepts for a spread adjustment:

  • Forward Approach: At the time of IBOR cessation, on a one-time basis, a forward spread curve would be generated based on observed market prices for the forward spread between the relevant IBOR and the replacement reference rate. This fixed curve would be used to determine the spread adjustment on each future date.
  • Historic Mean/Median Approach: The spread adjustment would be a single number that would be the historic mean or median spot spread between the relevant IBOR and the replacement reference rate, over a 5- or 10-year lookback period from the time of IBOR cessation. There would be a one-year phase-in from the current spot spread to the historical spread.
  • Spot-Spread Approach: The spread adjustment would be simply the spot spread between the relevant IBOR and the replacement reference rate at the time of conversion or over a brief period.

ISDA announced its summary of responses in December 2018, which revealed, among other things, that the majority of derivatives market participants preferred a Compounded Setting in Arrears with Historic Mean/Median Approach.

Separately, in May 2019, ISDA published (1) the Supplemental Consultation on Spread and Term Adjustments for Fallbacks in Derivatives Referencing USD LIBOR, CDOR, and HIBOR and Certain Aspects of Fallbacks for Derivatives Referencing SOR and (2) the Consultation on Pre-Cessation Issues for LIBOR and Certain Other Interbank Offered Rates (IBORs) (collectively, the 2019 ISDA Consultations), which sought market input on addressing certain issues that will apply to alternative risk-free rates and pre-cessation issues, respectively.

ARRC Consultations

In late 2018, ARRC working groups published separate consultations for fallback contract language for new cash products, including bilateral business loans, syndicated business loans, floating rate notes (notes offered and sold to investors), and securitizations. The ARRC consultations are informed by the 2018 ISDA Consultation, which preceded them, but they seek to develop alternative approaches where warranted that reflect the needs of market participants in cash products. These consultations do not address transitioning away from LIBOR for legacy assets, which will be addressed separately. Under the consultations, “Relevant Governmental Body” means the Board of Governors of the Federal Reserve Board (the Federal Reserve Board), the NY Fed, or a committee established by the Federal Reserve Board or the NY Fed, such as the ARRC.

ARRC Consultation—Syndicated Business Loans

This consultation was published September 2018, with final recommendations published April 2019. This consultation provides two alternatives:

  • Amendment Approach: establishes protocols for amending loan documents to transition from LIBOR but does not specify the replacement rate. This acknowledges that much remains unknown today about the replacement benchmarks and may be preferred for large balance loans.
  • Hardwired Approach: sets a prescribed waterfall for the replacement rate. This approach may be preferred for administrative ease with portfolios with large numbers of loans. Also, the ISDA Consultations and the ARRC Floating Rate Note and Securitization Consultation use only the hardwired approach.

Transition to a replacement rate would be triggered by:

  • Cessation triggers: the same trigger events as under the ISDA Consultations, authoritative public statements that LIBOR publication will cease, which triggers are effective upon actual cessation.
  • Pre-cessation triggers: a public statement by the regulatory supervisor for the administrator of LIBOR announcing that LIBOR is no longer representative, which statement can be effective prior to the actual cessation of LIBOR.
  • Additional “early opt-in” trigger events are provided separately for each of the amendment approach (loans in the market are replacing LIBOR) and the hardwired approach (other syndicated loans are priced over term SOFR).

Amendment Approach

The replacement reference rate would be an alternative benchmark agreed on between a borrower and an administrative agent, giving due consideration to the recommendation by a Relevant Governmental Body (RGB) or market convention.

  • Spread adjustment would be as agreed between a borrower and an administrative agent, giving due consideration to the recommendation by an RGB or market convention.
  • The approval mechanism would generally be negative consent by a simple majority of lenders or affirmative consent by a simple majority of lenders for the early opt-in triggers.

Hardwired Approach

The replacement benchmark would be determined under a waterfall (whichever is first available):

  • Term SOFR (corresponding tenor of LIBOR tenor being replaced).
  • Next Available Term SOFR (next shorter tenor).
  • Compounded SOFR, or alternatively Simple Average SOFR, which in either case may be in arrears with a lookback period, based on conventions: as recommended by an RGB or as observed in the market.
  • As agreed between a borrower and an administrative agent, giving due consideration to the recommendation by an RGB or market convention.

Spread adjustment would be determined under a waterfall (whichever is first available):

  • As recommended by relevant governmental body.
  • As selected by ISDA.
  • If no form of SOFR as listed above is available, then as agreed between a borrower and an administrative agent, giving due consideration to the recommendation by an RGB or market convention.

Approval mechanism: no amendment is needed unless the following occur:

  • If none of the SOFR waterfall steps is available, then negative consent by a simple majority of lenders.
  • If additional triggers are applied, then affirmative consent by a simple majority of lenders.

ARRC Consultation—Bilateral Business Loans

This consultation published December 2018 also provides amendment and hardwired alternatives. The main differences from the syndicated business loan consultation as published September 2018 are that:

  • References to an administrative agent and the required lenders instead are to the lender.
  • Under the amendment approach, alternatives are provided whereby the lender can select the replacement reference rate and spread adjustment, subject to negative consent of the borrower.

Under the hardwired approach:

  • Waterfall step 3 (Overnight SOFR) is omitted in light of ISDA’s announced preference for Compounded SOFR.
  • If no form of SOFR is available, then the lender selects the replacement reference rate and determines the spread adjustment.
  • No amendment is needed unless no form of SOFR is available, in which case the negative consent by the borrower is required.

USD ICE Bank Yield Index

Before 2019, there were some indications that IBA might endeavor to continue publication of LIBOR following 2021, with further enhancements and improvements. In January 2019, IBA published for comment a report introducing a new benchmark, the USD ICE Bank Yield Index (BYI). The proposal:

  • Expressly acknowledges that LIBOR faces an uncertain future.
  • Indicates that overnight risk-free rates (such as SOFR) are in most instances well suited to the derivatives market.
  • Observes that lenders, borrowers, and other cash market participants generally prefer a forward-looking term reference rate that represents average unsecured funding costs of a group of large banks.

The BYI is based entirely on actual arms-length transactions representing senior, unsecured, and uninsured USD borrowing costs of a group of large banks. The transactions include:

  • Primary wholesale market funding transactions (including inter-bank deposits, institutional CDs, and commercial paper), with data sourced directly from a group of large international banks (including most of the USD LIBOR panel banks) on a daily basis, minimum transaction size $10 million.
  • Secondary market bond transactions, as reported on the Trade Reporting and Compliance Engine of the Financial Industry Regulatory Authority, in bonds of a larger group of internationally active banks, minimum transaction size $2 million.

The BYI methodology gathers data on transactions of varying maturities up to approximately one year and buckets them into maturity ranges. The methodology targets at least ten transactions per maturity range. The transaction data are then used to generate a yield curve, from which one-month, three-month, and six-month rates would be plotted and published. The curve plotting aspect of the BYI methodology means that transactional inputs with a wide range of maturities are incorporated into the analysis, not just transactions with maturities corresponding to the publication tenors. IBA tested the BYI over a 12+ month period beginning January 2018 and found that:

  • The index was based on an average of 153 transaction inputs per day, with the majority being bond transactions.
  • The transaction target was met on each day of the testing period, for the maturity ranges corresponding to one-month, three-month, and six-month.
  • The resulting BYI generally correlated closely with reported LIBOR over the testing period, with some exceptions.

In October 2019, IBA published an updated methodology based on a rolling five-day average of unsecured bank funding and bond transaction yields. IBA has indicated that it is planning to further refine the BYI methodology and to publish further modeling and testing results. IBA currently plans to launch the BYI in first quarter 2020. IBA cautions there is no guarantee it will launch the BYI, however, and advises that market participants currently using LIBOR should not rely on the availability of the BYI.

BYI: Observations

Based on the minimum transaction size and average number of daily inputs during the testing period, assuming the average transaction size is not more than twice the minimum transaction size, it appears that a very rough estimate of the average daily volume of transactional inputs for the BYI is in the range of $1 to 2 billion. This is a rough guess, not provided by IBA. This would be a much less robust data set than underlies SOFR ($754 billion), or even the Overnight Bank Funding Rate ($197 billion) (see Figure, page 11). It is unclear whether the BYI will ultimately be viewed as IOSCO compliant or what the consequences of not being IOSCO compliant would be in terms of using this index.

On the positive side, the BYI is based only on market transactions, not expert judgment, and captures a market-based indication of large bank funding costs (including a bank credit component) on a forward term basis, with reported tenors that would match the most widely used USD LIBOR tenors. To the extent a requirement for a LIBOR replacement is that it be a successor index based on comparable information, the BYI is arguably more comparable to LIBOR than is SOFR. To the extent it can be confirmed that the BYI (with any further refinements) correlates closely to LIBOR, then replacing LIBOR with the BYI in any cash asset or contract would be close to value-neutral over its remaining term. In contrast, spread adjustments applied to SOFR are designed to be value-neutral on the date of substitution only and being static are not designed to assure correlation to LIBOR at any future date.

Additional Risks

Basis Risk: Given that the derivatives and cash markets may be subject to different approaches, swaps used to hedge cash exposures may convert differently than the cash exposures themselves, resulting in an imperfect hedge.

Tax Risks: Replacing LIBOR in any asset with a new benchmark may be a modification resulting in a tax recognition event and other tax risks including cancellation of debt income and loss of grandfathered status under the Foreign Account Tax Compliance Act.

  • Such modifications could also affect a securitization entity by impairing grantor trust or REMIC status.
  • In October 2019, the US Treasury and the IRS published proposed regulations that are designed to minimize the tax consequences from a benchmark transition.

Accounting Risks: Under hedge accounting, a hedge must be designated and documented at inception. Changes in a hedge may result in de-designation. ISDA and the Financial Accounting Standards Board are working on this issue.

Commercial Real Estate Floating Rate Loans

Historically, such loans have included provisions to the effect that if LIBOR is unavailable, the index will convert to prime. If such a provision were triggered, borrower and lender would likely want to renegotiate a replacement index.

New production loans typically have additional provisions for replacing LIBOR with an alternative rate. A replacement would be triggered if the lender determines there will be a replacement for LIBOR because of the actual or potential phase out of LIBOR. The replacement alternative rate would be based on the index generally used by US lenders as a replacement for LIBOR on floating rate commercial mortgage loans, as determined by the lender in good faith. In many cases, the above determinations are made solely by the lender, although this may vary from deal to deal. There would not necessarily be a spread adjustment. New production loans are not yet including language similar to the hardwired approach under the ARRC bilateral business loan consultation.

Legacy Real Estate Assets

For certain asset types there is less risk of conversion from LIBOR to another index because of, for example, replacement protocols being developed for that asset type, assets being shorter term and “burning off” before 2022, or assets of a bilateral nature that can be readily amended. For other asset types there is more concern about conversion away from LIBOR, in particular:

  • US LIBOR indexed residential mortgage loans: Such loans typically reference LIBOR as published at a specific location and may state that if LIBOR as so published is no longer available, the substitute index will be based on “comparable” information.
  • US LIBOR indexed student loans: Such loans typically provide that if LIBOR is no longer available, the lender or holder will “choose a comparable index”.

At this time, it is by no means clear that SOFR would be appropriately viewed as “comparable” to LIBOR or whether a margin could be added to the SOFR rate to reflect equivalency with the bank credit risk embedded in LIBOR.

For any legacy asset that is amended to replace LIBOR with an alternative index, there will be a concern whether the amendment constitutes a “significant modification” that could trigger gain or loss recognition for accounting and tax purposes.

Conclusion—Key Questions forthe Future

Efforts to create new risk-free rates based on extremely robust market data are laudable. Market participants should plan to transition away from LIBOR because its continuance cannot be assumed. Key questions that market participants face include the following:

  • Will there be a forward-looking term SOFR?
  • As a fallback, what other form of SOFR would be acceptable in the cash markets? (compounded vs. average, in advance vs. in arrears).
  • Will there be authoritative guidance on spread adjustments?
  • How best to contingency-plan for the absence of authoritative guidance on spread adjustments?
  • For new contracts, should the amendment approach or hardwired approach be used?
  • Will the USD ICE BYI be launched and become accepted as a replacement for LIBOR?
  • Will another alternative replacement for LIBOR emerge?
  • What can be done to mitigate risk on legacy assets and securitizations?
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By Gary A. Goodman and Alice F. Yurke

Gary A. Goodman is a partner in the real estate group at Dentons US LLP in New York, New York. Alice F. Yurke is a partner in the capital markets group at Dentons US LLP in New York, New York.