Federal Reserve proposes replacement rates under US Adjustable Interest Rate LIBOR Act
26 July 2022
On 19 July 2022, the US Federal Reserve requested feedback on proposed rules to establish replacement rates for US law-governed tough legacy USD LIBOR contracts under the US Adjustable Interest Rate (LIBOR) Act (the US Act) when the remaining USD LIBOR tenors are discontinued on 30 June 2023.
The US Act provides that a "board-selected benchmark replacement" will replace references to overnight, one-month, three-month, six-month and twelve-month USD LIBOR in tough legacy contracts on the first London banking day after 30 June 2023, but does not specify what the replacement benchmark will be. Instead, it describes the replacement rate as "a benchmark replacement identified by the [Board of Governors of the Federal Reserve System] that is based on SOFR, including any tenor spread adjustment […]". The US Act lists the tenor spread adjustments, which are the same as the ISDA fallback spreads published by Bloomberg.
Proposed replacement rates
The purpose of the proposed new rules is to establish what the replacement benchmark will be. The Federal Reserve is proposing to apply different replacements to different contract types.
Derivative transactions: for derivative transactions, the proposed replacement rate is ISDA's Fallback Rate (SOFR), being SOFR compounded in arrears plus the applicable Bloomberg spread.
Non-derivative transactions: for transactions that are not derivative transactions and are neither consumer loans nor contracts to which government sponsored enterprises are party (GSE contracts), the proposed replacement rates are:
(i) for contracts referencing overnight USD LIBOR, SOFR plus the applicable Bloomberg spread; and
(ii) for contracts referencing one-month, three-month, six-month or twelve-month USD LIBOR, CME Term SOFR plus the applicable Bloomberg spread.
Consumer loans: for consumer loans, the proposed replacement rate is CME Term SOFR plus one of the following:
(i) for the first year after 30 June 2023, a "transition tenor spread adjustment", being an amount that transitions gradually from (a) the difference between CME Term SOFR and the USD LIBOR value immediately before its discontinuation to (b) the applicable Bloomberg spread, to avoid a sudden shift in borrowers' borrowing rates after 30 June 2023, and
(ii) thereafter, the applicable Bloomberg spread.
Refinitiv has confirmed that it will publish "all-in" CME Term SOFR rates for consumer use, incorporating the transition tenor spread adjustment (during the first year) and the Bloomberg spread (thereafter).
GSE contracts: for GSE contracts, the proposed replacement rates are:
(i) for contracts referencing overnight USD LIBOR, SOFR plus the applicable Bloomberg spread; and
(ii) for contracts referencing one-month, three-month, six-month or twelve-month USD LIBOR, 30-day Average SOFR (published by the Federal Reserve Bank of New York) plus the applicable Bloomberg spread.
Synthetic USD LIBOR?
The FCA has recently asked for feedback on the market's USD LIBOR transition progress, to help it decide whether any synthetic USD LIBOR rate(s) will be required after 30 June 2023. In light of this, the Federal Reserve is also asking market participants whether its final rule should clarify that, if synthetic USD LIBOR is made available and a contract contains viable fallbacks but does not contain a pre-cessation/non-representativeness trigger, the fallbacks should apply nonetheless. This would avoid an unintentional fallback to synthetic USD LIBOR where alternative fallbacks have been negotiated by the contracting parties.
Authors: James Knight, Partner; and Kirsty McAllister-Jones, Expertise Counsel
