As the June 30, 2023 expiration date for London Interbank Offer Rate (LIBOR) approaches, businesses should assess impacted contracts and ensure adequate benchmark fallbacks are in place. Here is a rundown of what you need to know before the June 2023 LIBOR replacement date.
What Is LIBOR?
LIBOR is the common interest rate that banks used to borrow from one another. To calculate LIBOR, each day, the Intercontinental Exchange (ICE) would ask major global banks the rate at which they would lend to other banks, remove the highest and lowest rates, then use the average as the floating rate.
While this began as a rate for interbank loans in the ‘80s, it has since extended to student loans, car notes, and other types of loans. The LIBOR rate is still the benchmark rate for trillions of dollars in contracts.
How LIBOR Lost Favor
In 2012, major banks colluded to manipulate the daily LIBOR rate. Following the scandal, the ICE Benchmark Association (IBA) took over the administration of LIBOR, but that wasn’t enough to rebuild trust.
In 2014, the Alternative Reference Rates Committee (ARRC) was tasked with finding an alternative to LIBOR, and came up with the Secured Overnight Financing Rates (SOFR) and developed a plan to transition from LIBOR to SOFR.
The Financial Conduct Authority (FCA) determined that at the end of 2021, the International Bar Association (IBA) would stop most LIBOR tenors and settings, including the USD LIBOR. This meant that legacy contracts (i.e., those that still used LIBOR rates) would need to find alternative benchmark rates for their contracts. On June 30, 2023, LIBOR will expire overnight for one, three, six, and 12-month USD LIBOR contracts.
Adjustable Interest Rate (LIBOR) Act of 2022
Because there are too many active contracts without backup benchmark rates and therefore no fallback plan for after LIBOR expires, congress signed the Adjustable Interest Rate (LIBOR) Act as part of the Consolidated Appropriations Act into law in March 2022.
The objective of this legislation was to establish standard, uniform rules for “tough legacy contracts” under US law that will not mature by or before the replacement date and do not have fallback provisions.
LIBOR Act Final Ruling
The LIBOR Act passed in March 2022, and the Federal Reserve Board opened the ruling up for comments in July and August 2022. The final ruling was approved in December 2022 and went into effect on February 27, 2023.
The final ruling makes the following tenets explicit:
- The LIBOR Act supersedes all local and state laws that regard benchmark replacements. No other law outside of the LIBOR Act can overrule what the LIBOR Act says.
- SOFR-based benchmarks are the standard replacement for LIBOR contracts without fallback provisions that mature after the replacement date.
- Organizations can authorize a “determining person” who has the power to use board-selected benchmark replacements (or another of their choosing) as long as their contract allows it in legacy LIBOR contracts.
- Board-selected benchmark replacements are protected and cannot incur sanctions or other negative repercussions.
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