The ARRC’s progress to date and priorities going forward in the transition

The views and opinions expressed in this article are those of the thought leader and not those of CeFPro.

By Tom Wipf, Vice Chairman of Institutional Securities, Morgan Stanley / Chairman, ARRC

In summary, what are some of the ARRCs current priorities for 2020/2021?

The ARRC continues to focus on raising awareness of and creating tools to facilitate the ongoing transition away from LIBOR. This has taken many forms over the past few years, including the development of fallback language to be used in various types of cash products that reference LIBOR and publication of the ARRC’s Best Practices, which provide date-specific guidance for the market on various transition milestones, such as when it is most appropriate to cease new USD LIBOR production. Given the ARRC’s objective of ensuring the smoothest possible landing for market participants, we will also continue our focus on transition of legacy contracts in the months ahead. We’re particularly focused on helping transition those contracts classified as “tough legacy,” which may lack provisions that deal with the end of LIBOR or have provisions that would cause significant economic impacts that the parties may not have anticipated.

What progress has been made over the last six months?

The past six months have been an incredibly active time for the ARRC, with several significant publications, but I’ll name a few highlights. As previously mentioned, the publication of the ARRC’s Best Practices was a watershed moment for the USD LIBOR transition, as it clarified the timelines and interim milestones that the ARRC believes are appropriate and necessary for transitioning market participants away from USD LIBOR in a way that will minimize market disruption. The Best Practices also helped to establish clear recommended processes to ensure a smooth transition from USD LIBOR to SOFR, which many market participants were having difficulty discerning on their own. The ARRC also continues to finalize its spread adjustment for cash products – through numerous consultations, it has become clear that market participants prefer the ARRC to match ISDA’s calculated spread for many products to enhance market consistency. Another item to note is the ARRC’s publication on conventions for utilizing SOFR “in arrears” in syndicated business loans. Our view is that loan market participants have struggled to understand how product conventions may change as a result of the RFR transition, and this document is meant to shed light on how SOFR can be used in lending products today. Lastly, the ARRC has made significant progress over the past several months in terms of raising awareness of the LIBOR transition more broadly. Through events like the SOFR Summer Series – which hosted high-profile experts and leaders, such as New York Fed President John Williams and Bank of England Governor Andrew Bailey, to talk about the key issues of the transition – we were able to build awareness across a broader universe of stakeholders on what the end of LIBOR means for the markets and their organizations and what they can be doing to prepare for it now.

What are some of the recent trends in SOFR loan and bond markets?

Since the initial SOFR Floating Rate Notes were issued in 2018, that market has provided a source of durable financing for entities that prefer to fund on a floating rate basis. Since inception, well over half a trillion dollars have been raised using SOFR as a reference rate in the bond market. The loan market has had a notably slower start, although we look forward to market participants considering the ARRC’s near-term best practice for new LIBOR loans to include hardwired fallbacks by the third quarter of 2020. Ultimately, we feel utilization of these hardwired fallbacks removes the economic uncertainty that may exist in amendment-style fallback language. This is an important first step in the loan market transition – as market participants feel more comfortable about hardwiring in specific SOFR-related outcomes into their documents, they may ultimately feel greater comfort around engaging in lending directly on SOFR.

In your opinion, what are some of the key concerns associated with legacy contracts?

The ARRC’s primary concern is about legacy contracts that do not have legally viable or commercially reasonable language to deal with the end of LIBOR. Further, for many cash products, it is quite challenging to amend fallback language post-issuance, as doing so generally requires 100% of noteholder consent. Thus, our fear is that, all else equal, some of these “tough legacy” products will have no clear path forward beyond end-2021. For this reason, the ARRC has helped develop a legislative proposal for the New York State Legislature that would reduce negative consequences for these types of products and mitigate market disruption in advance of LIBOR cessation. The full proposed text is on the ARRC’s website, and we encourage all market participants to review carefully. It is important to understand what fallback scenarios might exist in our contracts absent this legislation and how the proposal remedies many of the problems we consider most challenging.

Can you share some insight on how LIBOR will end?

The assumption on the end of LIBOR has not changed since 2017. The FCA has an agreement with LIBOR panel banks to continue LIBOR submissions until year-end 2021. After this point, LIBOR panel banks may choose to withdraw from the LIBOR panel, at which point the rate’s existence or representativeness may no longer be guaranteed. We received an update from the FCA earlier this year stating that such a statement of non-representativeness could be made on a forward basis as early as the end of 2020, to be effective by YE’2021. Such a statement would provide a fallback trigger event for cash products that utilize ARRC fallback language as well as derivative products governed by ISDA’s protocol at the point this non-representativeness became effective. While the precise timing and nature of these actions are not yet confirmed, the official sector has been very clear about their expectations – market participants cannot rely on LIBOR existing after year-end 2021 and must plan accordingly. As the ARRC has stated several times over the past few months, it is critical that market participants continue to make progress on executing a complete transition away from LIBOR by the end of 2021.