President Biden on March 15 signed into law the Adjustable Interest Rate (LIBOR) Act, which aims to reduce uncertainty regarding the effect of ending LIBOR on existing USD LIBOR transactions, as part of an omnibus spending package.
The London Interbank Offered Rate, or LIBOR, is a global interest rate benchmark index based on the average of the interbank offered rates for deposits of various currencies and durations in the London market based on quotations of major banks. Floating interest rates embedded in many types of financial contracts, including loans, derivatives, and bonds, are often calculated by reference to LIBOR, with a spread of a given number of basis points. According to the Adjustable Interest Rate (LIBOR) Act (LIBOR Act), LIBOR is used as a benchmark rate in more than $200 trillion worth of existing contracts worldwide.
One week and two month USD LIBOR rates were discontinued on December 31, 2021, and all remaining USD LIBOR rates are scheduled to be discontinued on June 30, 2023. The Board of Governors of the Federal Reserve System (the Board), the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency have made it clear that supervised institutions, including banks and bank holding companies, should not to enter into new contracts that use USD LIBOR after December 31, 2021, subject to very limited exceptions.
Many legacy contracts that use LIBOR as a reference rate do not provide an effective fallback if LIBOR becomes unavailable, and many of these contracts are not easy to amend to provide a new interest rate benchmark. In April 2021, New York adopted a legislative “fix” for legacy contracts, but it only applied to contracts governed by New York law.
The LIBOR Act is similar in many respects to the New York legislation. Its key purpose is to establish a clear and uniform process on a nationwide basis for replacing LIBOR in existing contracts that do not provide for the use of a clearly defined or practicable replacement benchmark rate (other than with respect to the little-used one week and two month USD LIBOR tenors, which already have been discontinued and are excluded from the coverage of the LIBOR Act).
For contracts that contain no fallback provision (after disregarding certain types of fallbacks discussed below) or contain fallback provisions which neither identify a specific USD LIBOR benchmark replacement nor identify a person with authority to select a USD LIBOR benchmark replacement (referred to as a determining person), a benchmark replacement recommended by the Board will automatically replace the USD LIBOR benchmark in the contract after June 30, 2023. The recommended benchmark replacement will be based on the Secured Overnight Financing Rate (SOFR) published by the Federal Reserve Bank of New York, including any recommended spread adjustment and benchmark replacement conforming changes.
A spread adjustment is necessary because, unlike LIBOR, SOFR is effectively a risk-free rate. Benchmark replacement conforming changes are changes that the Board determines would address one or more issues surrounding the replacement of the contract’s benchmark, or (for non-consumer contracts) that are necessary or appropriate to implement the new benchmark in the reasonable judgment of the person responsible for calculating that benchmark under the contract (referred to as a calculating person).
The LIBOR Act provides that the following types of LIBOR replacement contract provisions will be disregarded as if not included in the contract:
For contracts that identify a determining person, the determining person will have the authority to replace the LIBOR rates with the Board-selected SOFR-based benchmark replacement. If the determining person does not select any non-LIBOR benchmark replacement, the Board‑selected benchmark replacement will automatically replace the USD LIBOR rates in the contract.
The LIBOR Act contains “safe harbor” provisions protecting from liability any person (including a determining person or calculating person) for:
For contracts subject to the Trust Indenture Act of 1939 (TIA), the LIBOR Act amends Section 316(b) of the TIA to provide that the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security shall not be deemed to be impaired or affected by any change occurring by the application of the LIBOR Act to any indenture security.
The LIBOR Act has no effect on contracts that already contain fallback provisions identifying a benchmark replacement that is not based in any way on USD LIBOR (including the prime rate or effective federal funds), or as to which the parties agree in writing to opt out of the application of the LIBOR Act.
The LIBOR Act preempts any state laws relating to the selection of a benchmark replacement (including the recent New York statute) or limiting the manner of calculating interest (insofar as such a provision applies to the selection or use of a Board-selected benchmark or benchmark replacement conforming changes). The LIBOR Act is not self-executing—it provides that no later than 180 days after the date of its enactment, the Board shall promulgate regulations to carry out the LIBOR Act.
Sharing insights and resources that help our clients prepare for and address evolving issues is a hallmark of Morgan Lewis. To that end, we maintain a resource center with access to tools and perspectives on timely topics driven by current events such as the global public health crisis, economic uncertainty, and geopolitical dynamics. Find resources on how to cope with the globe’s ever-changing business, social, and political landscape at Navigating the NEXT. to stay up to date on developments as they unfold. Subscribe now if you would like to receive a digest of new updates to these resources.
If you have any questions or would like more information on the issues discussed in this LawFlash, please the contact one of the authors, Kevin J. Biron, John M. Rosenthal, Charles A. Sweet, or any of the following other Morgan Lewis lawyers:
Boston
Sandra J. Vrejan
Los Angeles
David V. Chang
New York
Thomas V. D'Ambrosio
Washington
Jon R. Roellke