Bass, Berry & Sims attorney Katie Smalley authored an article for the Tennessee Bar Association (TBA) – Business Law Section outlining the transition from LIBOR to SOFR in commercial financing transactions. December 31, 2021 marked the date U.S. banks were to stop originating new LIBOR-based contracts – prompting a wider adoption of non-LIBOR floating rate benchmarks among that lending sector. While other floating rates remain viable options in the transition away from LIBOR, SOFR has become the most prevalent benchmark replacement rate as we enter this new phase of the transition.
The full article, “LIBOR’s Lapse: Has the Time for Term SOFR Arrived?” was originally published as part of the TBA Connect | Business Law Section email series on December 21, 2021 and is reprinted in full below with permission.
LIBOR’s Lapse: Has the Time for Term SOFR Arrived?
The moment has come – the moment that all have been awaiting since the summer of 2017 when the UK Financial Conduct Authority made its announcement to ultimately cease compelling reporting of the ubiquitous floating interest rate, LIBOR. December 31, 2021, marks the date upon which (i) U.S. banks are to cease entering into new LIBOR-based contracts and (ii) the first round of LIBOR tenor retirement is scheduled to occur. Since the original LIBOR cessation announcement, financial institutions and other market contributors have been eager, yet understandably hesitant, to commence originating non-LIBOR floating rate loans, but the upcoming year-end deadline has placed additional pressures on the adoption of alternative rates. Although the most highly utilized LIBOR tenors for U.S. financial arrangements has been delayed until June 2023, the recent announcement formally recommending Term SOFR as a replacement floating rate has propelled lenders and borrowers alike to proceed with new Term SOFR-based loans with increased fervor during the final half of 2021.
The growing prevalence of Term SOFR as the preferred rate for new floating rate loans comes from the ongoing review, analysis and recommendations of the Alternative Reference Rates Committee (ARRC). Established in 2014 by the Federal Reserve Board and the New York Fed, the ARRC has been on the front lines of U.S. financial institutions efforts to effectuate a smooth transition away from LIBOR and towards its recommended replacement benchmark – the Secured Overnight Financing Rate (SOFR). By regularly publishing recommended LIBOR fallback provisions and working with other market participants to publish SOFR rates and adopt fallback legislation, the ARRC has successfully established SOFR as the most frequently adopted replacement benchmark.
That being said, SOFR has not yet been universally adopted in commercial financing arrangements, and its status as the ubiquitous LIBOR replacement is not a foregone conclusion, as other alternative floating rates (e.g. BSBY, Ameribor, ICE Bank Yield Index), continue to be discussed by market participants as viable replacements. In fact, just last week the LSTA published a market advisory explicitly addressing the adoption of BSBY where “market participants see a credit sensitive rate as a more appropriate benchmark for use in certain transactions.”
However, the recent bulletin from the Office of the Comptroller of the Currency (OCC) indicates that non-SOFR rates will receive additional scrutiny, which has continued to solidify SOFR as a preferred benchmark alternative. It would seem that SOFR (or, more specifically Term SOFR) has become the leader in the race toward universal floating benchmarks, however LIBOR replacement will remain an important topic of discussion for all participants in commercial financial transactions for years to come as more post-LIBOR financial arrangements are originated and existing financings are evaluated in connection with LIBOR’s ultimate retirement.
This content was originally published as part of the TBA Connect | Business Law Section email series on December 21, 2021 and is reprinted with permission.