Federal banking regulators two weeks ago unexpectedly announced an extra 18 months for issuers and counterparties to transition away from LIBOR. But market participants will likely keep on the same path for issuing securities and other instruments using alternative rates, LIBOR specialists say.
The main impact of the extra time, says Jason Granet, Goldman Sachs managing director, will be on existing instruments and contracts that already have LIBOR built into them, and either need more time to terminate on their own or must have alternative rate references inserted.
The London Inter-bank Offered Rate (LIBOR) has been the go-to standard since the mid-1980s for most loans, structured products, contractual agreements, derivatives, corporate securities, floating rate instruments and benchmarked instruments.
Regulators began calling for a transition away from LIBOR after the 2008 financial meltdown amid mounting credibility concerns. It was slated to be discontinued at the end of 2021, but last week's announcement pushes that date back to June 2023.
In their announcement, federal regulators said they're trying to lay out a path forward in which issuers stop writing new U.S. dollar LIBOR instruments by the end of 2021, as planned, while giving legacy contracts the chance to mature before LIBOR ends.
The plan, said Federal Reserve Vice Chair for Supervision Randal Quarles, "ensures that the transition away from LIBOR will be orderly and fair for everyone—market participants, businesses, and consumers."
Under the plan, LIBOR's administrator, ICE Benchmark Administration Limited (IBA), will consult in early December on its intention to cease publication of the one week and two month U.S. Dollar LIBOR settings immediately following the LIBOR publication on December 31, 2021, and the remaining U.S. Dollar LIBOR settings immediately following the LIBOR publication on June 30, 2023.
From analysts: Overnight, one week, and two month LIBOR will very likely no longer be published. One, three six and twelve months will likely be published until June 2023. Even so, the regulators sent a strongly worded message to banks they should cease issuing loans referencing these indices in 2022 and in 2021.
Front book largely unaffected
Participants in institutional capital markets are well on their way to phasing out the use of LIBOR for new instruments, particularly in the bond and derivatives markets, and the extra time isn't expected to have a big impact, Granet said in a webcast last week by global advisory firm Dechert LLP.
"We've seen that market adoption take place," he said. "You've seen capital markets, bond markets continue to steadily show depth and structure."
In the U.S., the main replacement rate is expected to be the Secured Overnight Financing Rate (SOFR). The rate, set in arrears using a Federal Reserve index, is already being used in bond and derivative markets. "There seems to be a coalescing around the arrears" as the preferred SOFR rate-setting mechanism, said Granet.
Just last month, he said, Goldman Sachs issued a $2.5 billion benchmarked deal involving two notes that were SOFR-linked.
"We had done [SOFR] notes before," he said. "We've been active in that market."
In other markets, like commercial loans, no single standard has emerged. Instead, issuers are using other variants of SOFR, including simple average, compounded average, and advance. "There's an amalgamation of different rates," he said, although they're all SOFR-based.
Back book impact
The extra 18 months will have the biggest impact on existing instruments that wouldn't have expired before the end of 2021. Analysts are expecting to see a lot of confusion and litigation as parties try to agree on a replacement rate and conditions for contracts that are still in force.
"As the contracts change, there are going to be winners and losers," Charles Parekh, managing director of Duff & Phelps, said in a panel discussion earlier this year. "If the losses are large enough on one side, it often ends up in a lawsuit in which they're trying to blame someone or recoup some of those losses."
The extra time is expected to head off many of those conflicts because the instruments will have time to expire on their own and not require amending.
"What this really does is it helps back book and legacy securities runoff," said Granet.
The extra time also will help with legislation that is being written in the New York state legislature that, when enacted, will apply to the lion's share of instruments in effect since most securities are traded on Wall Street. Issuers, investors, counterparties, and other stakeholders have been weighing in on the legislation and the extra time will help ensure what comes out of the process is balanced.
"This likely allows for those things to get worked on over some good appropriate pace and get done," he said.