Automatic LIBOR Replacement

Automatic LIBOR Replacement

December 14, 2021 | By Keith Martin in Washington, DC

LIBOR would be replaced automatically with SOFR in some loans and other contracts under a bill that passed the US House of Representatives in early December by a 415-to-9 vote.

The bill would also bar lawsuits arising out of the selection or use of any replacement benchmark rate based on SOFR.

It must still pass the Senate.

The measure is an effort to avoid a chaotic transition after the UK Financial Conduct Authority stops publishing LIBOR. Some LIBOR tenors will cease publication at the end of 2021, and the remaining tenors will cease publication after June 30, 2023.

The UK Financial Conduct Authority plans to continue publishing “synthetic” LIBOR numbers for sterling-denominated contracts that will not require collecting interest-rate data directly from panel banks. It is considering publishing similar dollar LIBOR rates.

Under the House bill, LIBOR would be replaced automatically, in loans or other contracts that do not provide themselves for a replacement rate or make adequate provision to set such a rate, with a rate based on SOFR, plus a fixed spread adjustment that varies by tenor. The adjustment is .11448% for one-month LIBOR and .26161% for three-month LIBOR, the two most commonly-used tenors. The switch would take place on the first London banking day after June 30, 2023.

SOFR is a replacement rate for dollar-denominated instruments published by the Federal Reserve Bank of New York.

House action on the bill was delayed after the House banking committee included language to prevent the Internal Revenue Service from treating any shift in a benchmark rate as a taxable event. The House tax committee said the US Treasury has enough existing authority to sort out any tax issues in this area.

The IRS issued guidance in October 2020 to dispel fears that adjusting loan agreements and other contracts so that they still work after the UK stops publishing LIBOR will have adverse tax consequences. (For more detail, see “IRS Tries to Simplify LIBOR Transition” in the December 2020 NewsWire.)

Separate laws to avoid transition issues have passed in New York and Alabama.

The House bill overrides any state laws “insofar as they provide for use of a Benchmark Replacement,” meaning use of a new benchmark rate to replace LIBOR in loans or other contracts.

The parties to any loan or other contract can provide in the contract that it is not subject to the House bill.