Phase-Out of LIBOR: Revising Floating

Rate Loans to Implement Alternative

Reference Rates, ISDA Revisions

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

The audio portion of the conference may be accessed via the telephone or by using your computer's

speakers. Please refer to the instructions emailed to registrants for additional information. If you

have any questions, please contact Customer Service at 1-800-926-7926 ext. 1.

WEDNESDAY, JULY 24, 2019

Presenting a 90-minute encore presentation featuring live Q&A

Gary A. Goodman, Partner, Dentons, New York

Stephen S. Kudenholdt, Partner, Dentons, New York

Tips for Optimal Quality

Sound Quality

If you are listening via your computer speakers, please note that the quality

of your sound will vary depending on the speed and quality of your internet

connection.

If the sound quality is not satisfactory, you may listen via the phone: dial

1-866-755-4350 and enter your PIN when prompted. Otherwise, please

send us a chat or e-mail sound@straffordpub.com immediately so we can address

the problem.

If you dialed in and have any difficulties during the call, press *0 for assistance.

Viewing Quality

To maximize your screen, press the F11 key on your keyboard. To exit full screen,

press the F11 key again.

FOR LIVE EVENT ONLY

Continuing Education Credits

In order for us to process your continuing education credit, you must confirm your

participation in this webinar by completing and submitting the Attendance

Affirmation/Evaluation after the webinar.

A link to the Attendance Affirmation/Evaluation will be in the thank you email

that you will receive immediately following the program.

For additional information about continuing education, call us at 1-800-926-7926

ext. 2.

FOR LIVE EVENT ONLY

Program Materials

If you have not printed the conference materials for this program, please

complete the following steps:

• Click on the ^ symbol next to “Conference Materials” in the middle of the left-

hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see a

PDF of the slides for today's program.

• Double click on the PDF and a separate page will open.

• Print the slides by clicking on the printer icon.

FOR LIVE EVENT ONLY

LIBOR: The Way Forward

Presentation by:

Stephen S. Kudenholdt

Gary A. Goodman

July 24, 2019

5

• London Inter-bank Offered Rate (LIBOR) was developed and launched in

the mid-1980s by the British Bankers Association

• LIBOR is derived from submissions by panel banks, stating the rate at

which they could borrow funds from other banks in London, in various

currencies and tenors

• In practice LIBOR submissions have proven to be subject to

manipulation and tampering, as evidenced by the rate rigging scandal

that came to light in 2012

• Administration of LIBOR was shifted to the ICE Benchmark

Administration (IBA) in 2014

• In July 2017, the UK Financial Conduct Authority (FCA) announced a

potential phase-out of LIBOR by the end of 2021

A Brief History of LIBOR

6

• LIBOR is currently produced on a daily basis in 5 currencies: US dollar,

Euro, British pound sterling, Japanese yen, and Swiss franc

• 16 major money center banks are on the panel that contribute rates to

USD LIBOR. The banks are based in various jurisdictions and all have

operations in London

• LIBOR is calculated in various tenors including overnight, 1 week, 1

month, 2 months, 3 months, 6 months, 12 months

• IBA has taken significant steps to improve LIBOR, by establishing

oversight, surveillance and validation procedures designed to reduce the

possibility of manipulation

LIBOR Today

7

• Panel banks have an understandable reluctance to contribute rates to

support LIBOR, given the risk of future liability based on claims of

manipulation, notwithstanding improved internal controls and procedures

• Since the credit crisis, the actual reliance by banks on the interbank

lending market for funding operations has declined substantially

• As a result, at this time submissions by panel banks are to a large extent

based on “expert judgement” or estimates of the rates the submitting

banks would be charged, rather than actual or comparable transactions

• LIBOR therefore suffers both from reputational concerns and from an

absence of robust underlying market data, and is disfavored by policy

makers

Disadvantages of LIBOR

8

• LIBOR is forward looking, and is designed to predict a bank’s actual cost

of funds over a given time period in the future corresponding to the

relevant tenor

• If LIBOR were accurate, then a bank could reasonably price loans on a

forward basis by simply adding a margin reflecting the banks cost of

operations and profit margin as well as borrower risk

• LIBOR as an index also gives the borrower certainty of payment. For

example in a loan with 6 month LIBOR as an index, the rate would reset

every six months and the borrower would know its exact cost for the

upcoming period

• In contrast, if the borrowers rate were based an overnight index, its

borrowing cost would be far less certain

Advantages of LIBOR

9

• In July 2013 the International Organization of Securities Commissions issued its

Principles for Financial Benchmarks, following on the LIBOR rate rigging scandal

• The Principles are generally designed to address conflicts of interest, promote

internal controls, and improve governance and oversight

▪ Principle 6 indicates that Benchmark design should consider the “relative

size of the underlying market in relation to the volume of trading in the

market that references the Benchmark”

▪ Principle 7 recommends that a Benchmark be “based on prices, rates,

indices or values that have been formed by the competitive forces of

supply and demand” and “anchored by observable transactions entered

into at arm’s length between buyers and sellers in the market”

▪ Principle 8 provides a hierarchy for data inputs, ranking a submitter’s

own concluded arms-length transactions first, and expert judgement last

• Policymakers and industry participants in various countries, including the US,

have been working towards the development of new Benchmarks that follow the

IOSCO principles

IOSCO Principles

10

• The UK FCA is the regulator that has the power to direct panel banks to

continue to submit rates to IBA to help generate LIBOR, inasmuch as the

rate submission activity takes place in London

• In July 2017, head of the FCA Andrew Bailey indicated in a speech that

panel banks would no longer be compelled or encouraged by the FCA to

submit rates in support of LIBOR, effective at the end of 2021

• Notwithstanding recognized improvements in the production of LIBOR,

this policy is based on the absence of an active substantial underlying

market, inter-bank unsecured lending (see IOSCO Principle 6)

• This announcement does not mean that LIBOR will definitely cease to be

produced at the end of 2021; however, continued LIBOR after 2021

would be dependent on the willingness of a sufficient number of panel

banks to voluntarily continue to submit bids

What Mr. Bailey Said

11

A Visualization of Financial Stability & LIBOR

Priced off $500 million or less of underlying

daily transactions

USD LIBOR is estimated to be

referenced in $200 trillion worth of

financial contracts (equivalent to 10 times

US GDP).

Most of this exposure (95 percent) is in

derivatives, but USD LIBOR is also

referenced in an estimated:

o $3.4 trillion business loans

o $1.8 trillion in floating rate debt

o $1.8 trillion in securitizations

o $1.3 trillion retail mortgages & other

consumer loans

$200 Trillion

of USD LIBOR-Based Contracts

12

Data source: Alternative Reference Rates Committee,

Second Report, March 2018. Data as of year-end

2016.

• In the US, the leading new alternative reference rate under development

is the secured overnight financing rate (“SOFR”), which is produced by

the Federal Reserve Bank of New York

• SOFR is a rate, calculated and published daily, based on an average of

reported overnight repurchase transactions in US Treasury securities,

captured from several sources that report actual transaction data to the

NY Fed. The sources capture the vast majority of actual transactions of

this type

• The NY Fed commenced publication of SOFR in April 2018

• SOFR meets the IOSCO criteria in that the underlying market (US

Treasury repos) is extremely broad and robust, and there is very

substantial actual reported transaction data available based on market

transactions

SOFR

13

• SOFR underlying data is not limited to bank-to-bank lending, but rather is based

on transactions among participants in the broad US Treasury repo market who

may be banks, broker dealers, insurance companies, pension funds, private

equity funds, corporations, etc.

• SOFR is an overnight rate only; we understand that the data submitted to the NY

Fed is nearly all based on overnight transactions, and that it does not contain

data from which term rates could be derived

• For SOFR to be used as a lending rate to replace LIBOR, it will be essential for

term rates to be derived from SOFR

• SOFR is essentially a risk free rate, because the underlying transactions are fully

secured by high quality liquid collateral

• In contrast, LIBOR is an unsecured borrowing rate, and includes a component

that reflects the borrowing bank’s creditworthiness, especially as to longer tenors

• Unlike LIBOR, SOFR is a backward looking rate

• Because of these differences, SOFR can be expected to perform differently from

LIBOR

SOFR Attributes

14

15

Source: Alternative Reference Rates Committee, Second Report, March 2018.

Money Talks…

• In November 2014, the Alternative Reference Rates Committee (ARRC)

was convened to consider new US dollar risk free reference rates

• ARRC members include a number of major banks and industry groups,

and ARRC obtains input and participation from a broad range of market

participants as well as US regulators

• In June 2017, ARRC announced that it had selected SOFR as the

preferred alternative US dollar risk free reference rate, and as its

preferred alternative to USD LIBOR

• In March 2018, ARRC published its "Second Report", its most

authoritative and comprehensive publication to date regarding the

transition away from LIBOR

ARRC Implementation Plan

16

ARRC Implementation Plan (Continued)

• ARRC's Second Report outlines its “Paced Transition Plan,” which

would result in a forward SOFR curve from which term SOFR rates

could be derived The timeline contemplates the following completion

dates:

▪ End of 2018: trading begins in futures and uncleared swaps

referencing SOFR

▪ 2019 Q1: trading begins in cleared swaps that reference SOFR

▪ End of 2021: creation of term SOFR reference rate based on

SOFR derivatives market, provided the market has developed

enough to provide a robust rate

17

SOFR Futures Trading

• In May 2018, CME Group launched quarterly and monthly SOFR futures contracts, listed by CME and available for trading by CME Group clients

• The quarterly contract references daily compound SOFR over a future 3 month reference period. The reference periods end in March, June, September and December and are available up to 5 years out

• The monthly contract references average SOFR over a calendar month, and these contracts are available up to 7 months out

• It has recently been reported that there are now over 130 participants in the CME SOFR futures contract market with average daily trading volume running in the range of $68 billion notional, and with open interest at $479 billion notional

• Trading volume could be expected to increase significantly to the extent that market participants begin to incur financial obligations linked to SOFR, and therefore require SOFR futures contracts for hedging purposes

• At this time it is not yet clear that trading in SOFR futures will be robust enough to produce forward SOFR term reference rates that would meet IOSCO standards

18

• SOFR appears to be a very high quality, well designed reference rate for new transactions

• However, as an index to replace LIBOR in existing contracts without causing material economic gain or loss to either party, SOFR has these issues:

▪ SOFR is a risk free rate; it is unknown whether a market convention will develop to add a spread to SOFR to reflect the bank credit risk embedded in LIBOR

▪ SOFR is an overnight rate only; it is not known for certain that a term SOFR curve based on derivative trades will develop and will be accepted as a market convention

▪ Even if a term SOFR curve develops, under the ARRC timeline this will not be completed until the end of 2021, just when LIBOR would be phasing out, leaving no margin for error if there is a delay

Transition Risks

19

• Structured Finance Industry Group (SFIG) and other thought leaders have advocated that for the cash markets (including floating rate loans), there should be a true forward looking term SOFR derived from overnight SOFR.

• Forward looking term SOFR would predict SOFR over a future accrual period, based on market transaction inputs, and would be available at the beginning of the accrual period. It would be comparable to forward term LIBOR minus a credit component.

• However, the vast majority of LIBOR based transactions that might convert to SOFR are derivatives, which reference an overnight index and do not require a forward looking term index.

• For this reason, policymakers have discouraged use of a forward term replacement index for derivatives, and the ISDA consultation does not include a forward term SOFR.

• In line with this trend, and in light of concerns about the volume of SOFR futures trading, ARRC leadership has indicated that there can be no assurance that a forward looking term SOFR will actually develop

Will There Be a Term SOFR?

20

• While SOFR itself is an overnight rate, SOFR can be derived over a

given accrual period (e.g., 30 or 90 days) through a number of

approaches.

• “in advance” means SOFR for a given accrual period is calculated at the

start of the period, but based on overnight SOFR over the period ending

on or about the start of the period. In other words the observation period

is the period prior to the accrual period. For example, if the accrual

period is 2Q 2019, the rate is determined at the start of the accrual

period but based on actual overnight SOFR over 1Q 2019. Thus the in

advance approach is based on backward-looking or “stale” information,

but has the benefit of being known at the start of the accrual period.

In Advance or in Arrears SOFR

21

• “in arrears” means SOFR for a given accrual period is calculated at the

end of the period, based on overnight SOFR over the accrual period. In

other words the observation period is the same as the accrual period. For

example, if the accrual period is 2Q 2019, the rate is determined at the

end of the accrual period based on actual overnight SOFR during 2Q

2019. Thus the in arrears approach is based on actual rate information

during the accrual period, but has the disadvantage of not being known

at the start of the accrual period.

• When using the in arrears approach, the observation period may be

pushed back by a few days, so that the rate can be calculated a few days

prior to the end of the accrual period.

• The in arrears approach is favored by ISDA, and may be suitable for

corporate debt, but is viewed as not appropriate for consumer debt.

In Advance or in Arrears SOFR (continued)

22

• “compounded” means the daily overnight SOFR rate is compounded on

a daily basis over the observation period. This results in a slightly higher

rate for the observation period due to the effects of compounding, and is

thought to at least to some extent convert SOFR from an overnight rate

to a term rate.

• ISDA favors the compounded in arrears approach, which fits in well for

overnight indexed swaps over a fixed contractual time period.

• However market participants in the cash markets may find the calculations for

compounding to be burdensome.

• An alternative to compounding would be to simply average overnight

SOFR over the relevant observation period, and add a margin to adjust

the average overnight rate to a term rate.

• In the capital markets, a number of corporate debt issuances have been made

that reference SOFR. Generally, these transactions use averaging (not

compounding), in arrears.

Compounded or Average SOFR

23

• Because overnight SOFR is a risk free rate, whereas all tenors of LIBOR

include a bank credit component, when using SOFR as a replacement for

LIBOR it may be desirable to add a spread adjustment in order to

minimize any value transfer.

• Minimization of value transfer at time of conversion is deemed desirable

in order to avoid gains and losses.

• The spread adjustment would add on a factor to account for bank credit

risk over the relevant accrual period.

• The spread adjustment also would take into account the difference in

tenor between the tenor of LIBOR being replaced and the form of SOFR

being applied. This difference is greatest with overnight SOFR, and least

with forward looking term SOFR.

• Spread adjustment is not dynamic. It is a fixed amount that minimizes

value transfer at the point of benchmark replacement.

Spread Adjustment

24

• ISDA is planning to amend its 2006 Definitions so that its floating rate

options provide new fallbacks that would replace LIBOR (and other

IBORs produced in other jurisdictions) in the event of a permanent

discontinuation of LIBOR. ISDA published a multi-jurisdictional

consultation in July 2018 for comment on proposed fallbacks for various

IBORs.

• Under the ISDA consultation, the fallbacks for each relevant IBOR would

be triggered on the occurrence of:

• A public statement by the IBOR administrator that it will cease publication of the

benchmark, or

• A public statement by the regulatory supervisor of the administrator, or other

authorities with jurisdiction over the administrator, that the benchmark will

cease to be provided

ISDA Consultation

25

• In each case the effective date of the conversion to the fallback will be

the actual date of discontinuance of the relevant LIBOR.

• The consultation requested comment on proposed fallbacks including:

• Spot overnight reference rate, and convexity-adjusted overnight rate

• Compounded setting in arrears

• Compounded setting in advance

• The consultation also introduced three concepts for a spread adjustment:

• Forward Approach: At the time of IBOR cessation, on a one time basis a

forward spread curve would be generated based on observed market prices for

the forward spread between the relevant IBOR and the replacement reference

rate. This fixed curve would be used to determine the spread adjustment on

each future date.

ISDA Consultation (continued)

26

• Historic Mean/Median Approach: The spread adjustment would be a single

number that would be the historic mean or median spot spread between the

relevant IBOR and the replacement reference rate, over a 5 or 10 year

lookback period from the time of IBOR cessation. There would be a one-year

phase in from the current spot spread to the historical spread.

• Spot-Spread Approach: The spread adjustment would be simply the spot

spread between the relevant IBOR and the replacement reference rate at the

time of conversion, or over a brief period

• ISDA announced its summary of responses in December 2018,

indicating that the preferred combination is:

• Compounded Setting in Arrears with Historic Mean/Median Approach

ISDA Consultation (continued)

27

• ARRC working groups in late 2018 published separate consultations for

fallback contract language, for new cash products including: Bilateral

Business Loans, Syndicated Business Loans, Floating Rate Notes (notes

offered and sold to investors), and Securitizations.

• The ARRC consultations are informed by the ISDA Consultation which

preceded them, but seek to develop alternative approaches where

warranted that reflect the needs of market participants in cash products.

• These consultations do not address transitioning away from LIBOR for

legacy assets, which will be addressed separately

• Under the consultations, “Relevant Governmental Body” means the

Federal Reserve Board, the Federal Reserve Bank of New York

(“FRBNY”) or a committee established by the Federal Reserve or

FRBNY such as the ARRC.

ARRC Consultations

28

• This consultation was published September 2018 with final

recommendations published April 2019.

• This consultation provides two alternatives:

• Amendment approach: establishes protocols for amending loan documents to

transition from LIBOR, but does not specify the replacement rate. This

acknowledges that much is not known today about the replacement

benchmarks, and may be preferred for large balance loans.

• Hardwired approach: sets a prescribed waterfall for the replacement rate. May

be preferred for administrative ease with portfolios with large numbers of loans.

Also, both the ISDA Consultation, and the ARRC Floating Rate Note and

Securitization Consultation, use only the hardwired approach.

• Triggers: transition to a replacement rate would be triggered by

• Cessation triggers: the same trigger events as under the ISDA consultation,

authoritative public statements that LIBOR publication will cease. Triggers are

effective upon actual cessation.

ARRC Consultation - Syndicated Business Loans

29

• Pre-cessation triggers: a public statement by the regulatory supervisor for the

administrator of LIBOR announcing that LIBOR is no longer

representative. Can be effective prior to the actual cessation of LIBOR

• Additional “early opt-in” trigger events are provided separately for each of the

amendment approach (loans in the market are replacing LIBOR) and the

hardwired approach (other syndicated loans are priced over term SOFR)

• Amendment approach:

• Replacement reference rate would be an alternate benchmark agreed between

Borrower and Administrative Agent, giving due consideration to

recommendation by Relevant Governmental Body or market convention

• Spread Adjustment would be as agreed between Borrower and Administrative

Agent, giving due consideration to recommendation by Relevant Governmental

Body or market convention

• Approval mechanism would generally be negative consent by majority Lenders,

or affirmative consent by majority Lenders for the early opt-in triggers

ARRC Consultation - Syndicated Business Loans

(continued)

30

• Hardwired approach:

• Replacement benchmark determined under a waterfall (whichever is first

available):

• 1a. Term SOFR (corresponding tenor of LIBOR tenor being replaced)

• 1b. Next Available Term SOFR (next shorter tenor)

• 2. Compounded SOFR, or alternatively Simple Average SOFR, which in either case may be in

arrears with a lookback period, based on conventions:

• Recommended by Relevant Government Body, or

• Observed in the market

• 3. As agreed between Borrower and Administrative Agent, giving due consideration to

recommendation by Relevant Governmental Body or market convention

• Spread adjustment determined under a waterfall (whichever is first available):

• As recommended by Relevant Governmental Body

• As selected by ISDA

• If no form of SOFR as listed above is available, then as agreed between Borrower and Administrative

Agent, giving due consideration to recommendation by Relevant Governmental Body or market

convention

• Approval mechanism: no amendment is needed unless

• If none of the SOFR waterfall steps are available, then negative consent by majority Lenders

• If additional triggers applied, then affirmative consent by majority Lenders

ARRC Consultation - Syndicated Business Loans (continued)

31

• This consultation published December 2018 also provides amendment

and hardwired alternatives.

• Main differences from the Syndicated Business Loan consultation as

published September 2018 are that:

• References to Administrative Agent, Required Lenders instead are to the

Lender

• Under the amendment approach, alternatives are provided whereby Lender

can select the replacement reference rate and spread adjustment, subject to

negative consent of the Borrower.

• Under the hardwired approach:

• Waterfall step 3 (Overnight SOFR) is omitted in light of ISDA’s announced preference for

Compounded SOFR

• If no form of SOFR is available, then Lender selects replacement reference rate and also

determines spread adjustment

• No amendment is needed unless no form of the SOFR is available, in which case negative consent

by Borrower is required.

ARRC Consultation - Bilateral Business Loans

32

• Prior to 2019, there were some indications that IBA might endeavor to

continue publication of LIBOR following 2021, with further enhancements

and improvements

• In January 2019, IBA published for comment a report introducing a new

benchmark, the U.S. Dollar ICE Bank Yield Index (BYI). The proposal:

• Expressly acknowledges that LIBOR faces an uncertain future.

• Indicates that overnight risk free rates (such as SOFR) are in most instances

well suited to the derivatives market

• Observes that lenders, borrowers and other cash market participants generally

prefer a forward looking term reference rate that represents average unsecured

funding costs of a group of large banks

USD ICE Bank Yield Index

33

• The BYI is based entirely on actual arms-length transactions

representing senior, unsecured, uninsured USD borrowing costs of a

group of large banks. The transactions include:

• Primary wholesale market funding transactions (including inter-bank deposits,

institutional CDs, and commercial paper), with data sourced directly from a

group of large international banks (including most of the USD LIBOR panel

banks) on a daily basis, minimum transaction size $10 million

• Secondary market bond transactions, as reported on TRACE, in bonds of a

larger group of internationally active banks, minimum transaction size $2 million

• The BYI methodology gathers data on transactions of varying maturities

up to approx. 1 year, and buckets them into maturity ranges. The

methodology targets at least 10 transactions per maturity range.

USD ICE Bank Yield Index (continued)

34

• The transaction data are then used to generate a yield curve, from which

1 month, 3 month and 6 month rates would be plotted and published.

• The curve plotting aspect of the BYI methodology means that

transactional inputs with a wide range of maturities are incorporated into

the analysis, not just transactions with maturities corresponding to the

publication tenors

• IBA tested the BYI over a 12+ month period beginning January 2018,

and found that:

• The index was based on an average of 153 transaction inputs per day, with the

majority being bond transactions

• The transaction target was met on each day in the testing period, for the

maturity ranges corresponding to 1 month, 3 month and 6 month

USD ICE Bank Yield Index (continued)

35

• The resulting BYI generally correlated closely with reported LIBOR over the

testing period, with some exceptions

• IBA is planning to further refine the BYI methodology, and to publish

further modelling and testing results later in 2019.

• IBA currently plans to launch the BYI in 1Q 2020. However IBA cautions

that there is no guarantee it will launch BYI, and advises that market

participants currently using LIBOR should not rely on the availability of

BYI.

USD ICE Bank Yield Index (continued)

36

• Based on the minimum transaction size and average number of daily

inputs during the testing period, assuming the average transaction size is

not more than twice the minimum transaction size, it appears that a very

rough estimate of the average daily volume of transactional inputs for the

BYI is in the range of $1 to 2 billion. This is a rough guess, not provided

by IBA.

• This would be a much less robust data set than underlies SOFR ($754

billion), or even the Overnight Bank Funding Rate ($197 billion) (see

slide 11).

• It is unclear whether the BYI will ultimately be viewed as IOSCO

compliant, or what the consequences of not being IOSCO compliant

would be in terms of using this index.

Observations re the USD ICE Bank Yield Index

37

• On the positive side, the BYI is based only on market transactions, not

expert judgement, and does capture a market based indication of large

bank funding costs (including a bank credit component) on a forward

term basis, with reported tenors that would match the most widely used

USD LIBOR tenors.

• To the extent that a requirement for a LIBOR replacement is that it be a

successor index based on comparable information, BYI is arguably more

comparable to LIBOR than SOFR is.

• To the extent that it can confirmed that BYI (with any further refinements)

correlates closely to LIBOR, then replacing LIBOR with BYI in any cash

asset or contract would be close to value neutral over its remaining term.

• In contrast, Spread Adjustments applied to SOFR are designed to be

value neutral on the date of substitution only, and being static are not

designed to assure correlation to LIBOR at any future date.

Observations re the USD ICE Bank Yield Index

(continued)

38

• Basis risk: given ISDA and cash products may be taking different

approaches, swaps used to hedge cash exposures may convert

differently than the cash exposures themselves resulting in an imperfect

hedge

• Tax risks: replacing LIBOR in any asset with a new benchmark may be

a modification resulting in a tax recognition event and other tax risks

including cancellation of debt income and loss of grandfathered FATCA

status

• Such modifications could also affect a securitization entity by impairing grantor

trust or REMIC status

• SFIG has submitted a letter to Treasury and IRS requesting guidance to avoid

these risks

• Accounting risks: Under hedge accounting, a hedge must be

designated and documented at inception. Changes in a hedge may

result in dedesignation. ISDA and FASB are working on this issue.

39

Additional Risks

• Historically, such loans have included provisions to the effect that if

LIBOR is unavailable, the index will convert to Prime

• If such provision were triggered, borrower and lender would likely want

to renegotiate a replacement index

• New production loans typically have additional provisions for replacing

LIBOR with an alternative rate

• A replacement would be triggered if lender determines there will be a

replacement for LIBOR due to the actual or potential phase out of LIBOR

• The replacement alternative rate would be based on the index generally used

by US lenders as a replacement for LIBOR on floating rate commercial

mortgage loans, as determined by lender in good faith

• In many cases the above determinations are made solely by lender, although

this may vary from deal to deal

• There would not necessarily be a spread adjustment

• New production loans are not yet including language similar to the

hardwired approach under the ARRC Bilateral Business Loan

consultation

40

CRE Floating Rate Loans

• For certain asset types there is less risk of conversion from LIBOR to another

index due to: replacement protocols being developed for that asset type; assets

being shorter term and “burning off” before 2022; assets of a bilateral nature that

can be readily amended

• For other asset types there is more concern about conversion away from LIBOR,

in particular:

▪ US LIBOR indexed residential mortgage loans: such loans typically reference

LIBOR as published at a specific location, and may state that if LIBOR as so

published is no longer available, the substitute index will be based on “comparable”

information

▪ US LIBOR indexed student loans: such loans typically provide that if LIBOR is no

longer available, the lender or holder will “choose a comparable index”

▪ At this time, it is by no means clear that SOFR would be appropriately viewed as

“comparable” to LIBOR or whether a margin could be added to the SOFR rate to

reflect equivalency with the bank credit risk embedded in LIBOR

• For any legacy asset that is amended to replace LIBOR with an alternate index,

there will be a concern as to whether the amendment constitutes a “significant

modification” that could trigger gain or loss recognition for tax purposes

Legacy Assets

41

• Legacy ABS that have notes or certificates indexed to LIBOR have a wide variety of

provisions in the event that LIBOR is no longer available

• CMBS and SFR deals typically switch to Prime; however the provisions may not take into

account the typical spread between LIBOR and Prime

• Some legacy transactions, including many CLOs, simply revert to the latest published rate

in the event LIBOR is no longer published, in effect converting a floating rate instrument to

fixed rate

• Some legacy transactions, in particular RMBS and many ABS, require that if LIBOR is no

longer published, 1) a transaction party must obtain quotes for interbank deposits from a

number of banks, and use the average for the index, and 2) if such quotes cannot be

obtained, then the last published LIBOR is used

• If LIBOR is discontinued, transaction parties who are required to obtain quotes (as in 1)

above) may find that there is no way to avoid their contractual obligations to do so absent

litigation

• Amending a legacy securitization transaction to convert from LIBOR to another reference

rate would be problematic, because such amendments may require consent from each

investor affected

• Also note risk of basis risk mismatch between LIBOR based legacy securities and

underlying assets

Legacy ABS

42

• New ABS transactions continue to be issued that reference LIBOR

• Some new transactions contain provisions designed to smooth the transition to a

new index, if LIBOR is discontinued

• As an example, new transition provisions might:

▪ Define a LIBOR termination event (events that demonstrate that LIBOR

has been discontinued),

▪ Allow for an alternate reference rate to be selected from among

reference rates that are officially recognized or that have come to be

used in new similar transactions,

▪ Provide a mechanism to set a margin to reflect the anticipated spread

between the new rate and LIBOR, and

▪ Specify a notice and approval procedure that limits the number of

investors required to consent

• There is a need for near term focus to develop standardized transition provisions

of this type across asset classes

Interim ABS

43

• Efforts to create new risk-free rates based on extremely robust market

data are laudable

• Market participants generally should be planning to transition away from

LIBOR as it continuance cannot be assumed

• Key questions that market participants face include:

• Will there be a forward looking term SOFR?

• As a fallback, what other form of SOFR would be acceptable in the cash

markets? (Compounded vs average, in advance vs in arrears)

• Will there be authoritative guidance on spread adjustments?

• How best to contingency plan for the absence of authoritative guidance on

spread adjustments?

• For new contracts should the amendment or hardwired approach be used?

• Will the USD ICE Bank Yield Index be launched and become accepted as a

replacement for LIBOR?

• Will another alternative replacement for LIBOR emerge?

• What can be done to mitigate risk on legacy assets and securitizations?

44

The Way Forward

Contact Us

Stephen S. Kudenholdt

Partner, New York

1221 Avenue of the Americas

New York, NY 10020

D +1 212 768 6847

steve.kudenholdt@dentons.com

Dentons is the world's largest law firm, delivering quality and value to clients around the globe. Dentons is

a leader on the Acritas Global Elite Brand Index, a BTI Client Service 30 Award winner and recognized by

prominent business and legal publications for its innovations in client service, including founding Nextlaw

Labs and the Nextlaw Global Referral Network. Dentons' polycentric approach and world-class talent

challenge the status quo to advance client interests in the communities in which we live and work.

www.dentons.com.

© 2018 Dentons. Dentons is a global legal practice providing client services worldwide through its member firms and affiliates. This publication is not designed to provide legal advice and you should not take, or refrain from taking, action based on its content. Please see dentons.com for Legal Notices.

45

Gary A. Goodman

Partner, New York

1221 Avenue of the Americas

New York, NY 10020

D+1 212 768 6916

gary.goodman@dentons.com

45