A discussion draft of the Adjustable Interest Rate (LIBOR) Act of 2021, published by Rep. Brad Sherman (D-Calif), would ease the transition from LIBOR to another benchmark rate, the Secured Overnight Financing Rate (SOFR), under current contracts with fallback language and under contracts that do not provide for a fallback benchmark rate. The discussion draft also would clarify the tax treatment of benchmark replacements and provide for related rulemaking by the Federal Reserve and the Treasury Department.
Key provisions. The impending discontinuance of LIBOR raises many issues about how the transition to a new standard should work. The discussion draft defines key terms and provides for safe harbor regarding legal liability for contracts that have or will need to specify a benchmark replacement.
Specifically, the discussion draft provides that the selection or use of a Fed-selected benchmark replacement (i.e., based on SOFR) as a benchmark replacement would be deemed to be:
- a commercially reasonable replacement for and a commercially substantial equivalent to LIBOR;
- a reasonable, comparable, or analogous term for LIBOR;
- a replacement that is based on a methodology or information that is similar or comparable to LIBOR; and
- substantial performance by any person of any right or obligation relating to or based on LIBOR.
New York, being one of the U.S. centers for financial contracts, has pursued similar legislation. Governor Andrew Cuomo signed into law in early April S 297/A164B, which seeks to provide clarity on the transition from LIBOR to a new standard. The Alternative Reference Rates Committee (ARRC) had previously expressed support for the New York bills and likewise supported Cuomo’s decision to sign the final version of the legislation into law. Representative Sherman’s discussion draft, however, would supersede state laws and preempt any contrary state laws.
House FSC hearing. The discussion draft also was the subject of a hearing held by the House Financial Services Committee’s Subcommittee on Investor Protection, Entrepreneurship and Capital Markets, which is chaired by Rep. Sherman. House FSC Chairwoman Maxine Waters (D-Calif) observed in her opening remarks that LIBOR will cease to exist in 2023 and that a smooth transition to a new standard is also important for consumers.
"LIBOR proved to be easily manipulated when banking authorities around the globe found extensive collusion by megabanks like JPMorgan, Citigroup, Barclays, Deutsche Bank, UBS, and the Royal Bank of Scotland, to fix the LIBOR to their own advantage," said Rep. Waters. "These institutions paid billions of dollars in fines to settle their fraud, but now we need to protect consumers, investors, and the United States financial system as the markets transition away from the LIBOR."
John Coates, Acting Director of the SEC’s Division of Corporation Finance, testified that the SEC’s several divisions, including the Division of Trading and Markets and the Division of Examinations, were monitoring different types of market participants, exchanges, and counterparties. With respect to Regulation Best Interest, which broker-dealers have been required to comply with since late June 2020, Coates cautioned that broker-dealers may need to consider whether LIBOR-linked securities recommended to retail customers have sufficient fallback language regarding the LIBOR transition.
The Securities Industry and Financial Markets Association, although not appearing at the hearing alongside federal regulators, nevertheless submitted testimony for the record in support of federal legislation to aid the transition away from LIBOR. SIFMA, among other things, explained that contracts related to legacy transactions are difficult to amend because of the lack of homogeneity in cash market transactions versus swaps and futures and because of the number of negotiations that would have to occur, which may number in the hundreds or thousands.
The U.S. Chamber of Commerce also submitted comments to the subcommittee hearing. According to the Chamber, Congress should pass LIBOR transition legislation with provisions to help protect nonfinancial corporates, which the organization said have been unable to obtain SOFR-based loans from banks.