The synthetic rate is designed to give an estimate of what sterling LIBOR might have been in the future and will be calculated as a forward-looking term version of sterling LIBOR.
The UK’s Financial Conduct Authority (FCA) has just ended its consultation (CP21/29) on whether and how to permit the legacy use of one-, three- and six-month sterling LIBOR from 1 January 2022 to ensure limited market disruption for certain tough legacy loans that link to LIBOR but expire after LIBOR is discontinued. The FCA will require the LIBOR benchmark administrator to publish a “synthetic” LIBOR for the duration of 2022, beyond the cessation of LIBOR panels on 31 December 2021.
The synthetic rate is designed to give an estimate of what sterling LIBOR might have been in the future and will be calculated as a forward-looking term version of sterling LIBOR (the ICE Term SONIA Reference Rates provided by ICE Benchmark Administration for sterling). The first publication of the sterling LIBOR synthetic rate will be on 4 January 2022 and is only intended to be used for tough legacy contracts, not new products.
Before the end of 2021, the FCA will confirm which legacy contracts are allowed to use the synthetic LIBOR rate (noting, however, that synthetic LIBOR will not be published indefinitely). They have also stated that they will consider progressively restricting continued permission to use synthetic LIBOR in legacy contracts if this would help maintain progress towards an orderly cessation.
Tough legacy contracts are those that are not easily amended, or where the conversion of such contracts is not straightforward as they were typically entered into when it was not foreseen that there would be a permanent discontinuation of LIBOR. The asset classes being considered by the FCA as tough legacy contracts linked to sterling LIBOR include floating rate notes, securitisations, loans and mortgages.
Such contracts either provide that in the event LIBOR becomes unavailable, the interest rate will be the rate applied on the last preceding interest determination date that LIBOR was available (effectively creating a fixed rate of interest to maturity) or they do not contemplate LIBOR becoming unavailable and have no associated mechanisms to account for this event.
There are particular issues with legacy securitisations referencing the one-, three- and six-month sterling LIBOR versions as such structures often contain swaps and the cessation of sterling LIBOR could cause mismatches in the cash flows of the securitisation. Further, there are a number of outstanding legacy bonds that were documented before it was contemplated that LIBOR would cease to exist, with the result that common fallback provisions in such bonds would result in floating rate bonds becoming fixed rate on the permanent cessation of LIBOR. Finally, further issues are expected with more complex multicurrency, large syndicated loans referencing sterling LIBOR, which may take time to renegotiate and may not be renegotiated before the end of 2021.
It is worth highlighting that the FCA has stated that the decision to require publication of some sterling LIBOR settings on a synthetic basis are not determinative of any future decisions in respect of U.S. dollar LIBOR from the end of June 2023.
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Duane Morris attorneys assist lenders in formulating their documentation and strategy for post-LIBOR loans and applying amendments that address the interest rate changes in legacy loans through general, descriptive measures. As the end of LIBOR draws closer, Duane Morris’ LIBOR Transition Team will continue to monitor developments and issue additional Alerts. Stay tuned to the LIBOR Transition Team webpage and blog for updates.
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