US loan market unprepared for Libor transition

NEW YORK, Oct 5 (LPC) - US institutional investors are unprepared for the looming transition to the Secured Overnight Financing Rate (SOFR) as the 2021 date to replace Libor, the reference rate for more than US$350trn of assets globally, draws closer.

Market participants do not currently view the replacement of Libor as a pressing issue and are relying on the wider market to come up with a solution, according to a poll of attendees at the 24th annual ABS East conference in Miami.

Almost 38% of respondents said they will “let the market figure it out” when polled on their institution’s level of engagement on the transition away from Libor. Another 34% said they will be engaged at the “appropriate time.”

“What I’m concerned about is that I still see a concerning lack of preparation,” Eli Stern, a principal at EY said on a conference panel, adding that investors were adopting a ‘wait and see’ approach. “That is not going to cut it.”

Andrew Bailey, chief executive officer of the UK’s Financial Conduct Authority (FCA), said last year that there were insufficient transactions underpinning Libor, which is used to set the rate on loans tied to corporate borrowings and mortgage payments.

The US$1.1trn US leveraged loan market, which finances companies including retailer Party City and American Airlines, is a small part of the markets that rely on Libor, but presents its own transition challenge as millions of documents will need to be reworked.

“The transition away from Libor will be much smoother if market participants are not only educated on the risks involved, but also take proactive steps to reduce their exposure to such risks,” research firm Covenant Review wrote in a September 26 note.


The Federal Reserve (Fed) and the Federal Reserve Bank of New York set up the Alternative Reference Rates Committee (ARRC) in 2014 to identify best practices for alternative rates after the Financial Stability Oversight Council and Financial Stability Board raised concerns about the reliability of existing benchmarks.

The ARRC recommended shifting to SOFR, which began trading earlier this year. It now has about US$800bn of trades a day and was set at 2.18% on October 4.

Libor is an unsecured benchmark set by banks based on the rate that they would charge to lend to each other. Three-month Libor, the rate companies frequently use to set their payments, was 2.41% Thursday.

In September ARRC asked for feedback by November 8 on two fallback contract alternatives for floating-rating notes and syndicated business loans to identify the best way for existing contracts to move to a new benchmark if Libor is no longer viable.

Administrative agents and borrowers can use an “amendment approach” when triggered to amend an agreement to replace Libor with an alternative benchmark. Required lenders would have the right to object.

A second “hardwired” option allows a predetermined transition when loans are originated and credit agreements are put in place. This approach would prompt a waterfall of potential replacement rates and spread adjustments after a trigger event.


After Bailey’s comments in 2017, both Collateralized Loan Obligations (CLOs), the largest buyer of leveraged loans, and borrowers included new language in loan documents to reference potential alternative rates, but none have issued on SOFR to date.

Other asset classes have already made the jump, however, with Fannie Mae in July issuing a three-tranche US$6bn SOFR debt transaction.

Last month, the FCA and the Bank of England Prudential Regulation Authority sent letters to bank and insurance company chief executive officers seeking assurance that their firms understand the risks associated with the benchmark transition.

The regulators gave institutions a deadline of December 14 to respond with a board-approved summary of key risks relating to Libor discontinuation and details of actions that will be taken to mitigate them. A Fed spokesperson declined to comment on whether US regulators would consider a similar step.

“Regulators have said ‘we’re going to do a transition out by 2021’ and I think that has given a false sense of security that the people in charge will take care of this,” said Patrick Sargent, a partner at law firm Alston & Bird, adding that participants do not currently appreciate the size or complexity of the financial instruments that need to move to the new benchmark.

“People are working [on the issue], so that’s good news, but if I’m advising my banking or my hedge fund clients, I’m saying, ‘you guys better have someone involved and have a say at the table and be preparing systems operationally.’” (Reporting by Kristen Haunss Editing by Tessa Walsh and Jon Methven)