Background Scandals exposed around 2013 revealed that certain market players had been manipulating the LIBOR index during the 2008 financial crisis, and market confidence in LIBOR began to wane. Financial regulators and market participants began to search for alternative reference rates and develop plans for a transition away from LIBOR. Key milestones in this process include the following: • 2014 — The Board of Governors of the Federal Reserve System (Board) and the Federal Reserve Bank of New York (FRBNY) convened the Alternative Reference Rates Committee (ARRC) to identify a recommended replacement to LIBOR. • June 2017 — The ARRC identified the Secured Overnight Financing Rate (SOFR) as its recommended replacement for USD LIBOR. • October 2020 — The International Swaps and Derivatives Association (ISDA) published the ISDA 2020 IBOR Fallbacks Protocol (Protocol), a contractual protocol by which parties to derivative transactions governed by ISDA documentation and other financial contracts can agree (by electing to adhere to the Protocol) to incorporate robust contractual fallback provisions that replace LIBOR with an alternative benchmark based on SOFR. • November 2020 — The Office of the Comptroller of the Currency (OCC), Board, and Federal Deposit Insurance Corporation (FDIC) issued an interagency statement stating that banking organizations should generally not enter into new contracts referencing USD LIBOR after December 31, 2021. • March 2021 — The United Kingdom’s Financial Conduct Authority (FCA) announced that after December 31, 2021, the ICE Benchmark Administration Limited (IBA) would cease publishing 24 currency and tenor pairs (known as settings) of LIBOR; however, it would continue to publish the overnight, and one-, three-, six-, and 12-month tenors of USD LIBOR through June 30, 2023. The FCA also proposed that the IBA continue publishing the one-, three-, or six-month USD LIBOR settings on a “synthetic” basis until September 30, 2024, even though such synthetic LIBOR settings are “not representative of the markets that the original LIBOR settings were intended to measure.” • April 2021 — New York adopted N.Y. Gen Oblig. Law art 18-C addressing the effect of LIBOR discontinuance on contracts. Following this, other states (including Alabama, Florida, Indiana, Nebraska and Tennessee) adopted similar legislation. • March 2022 — Congress enacted the Adjustable Interest Rate (LIBOR) Act (LIBOR Act) to establish a set of default rules to apply to “tough” legacy contracts subject to U.S. law (i.e., contracts that use LIBOR as the reference rate but do not include adequate fallback provisions in the event LIBOR is discontinued). • December 2022 — Pursuant to its authority under the LIBOR Act, the Board approved its final Regulation Implementing the Adjustable Interest Rate (LIBOR) Act (LIBOR Regulations). • June 30, 2023 — Scheduled date for cessation of the overnight and one-, three-, six-, and 12-month tenors of USD LIBOR. What is SOFR? The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities and is published by the Federal Reserve Bank of New York. There are several differences between LIBOR and SOFR including the following: • LIBOR is unsecured and therefore includes an element of bank credit risk, which may cause it to be higher than SOFR. • LIBOR may include term premiums and reflect supply and demand conditions in wholesale unsecured funding markets, which may cause LIBOR to be higher than SOFR. • LIBOR is a forward-looking rate (meaning that the rate is known at the time it is applied), while SOFR is inherently a backward-looking rate (meaning that the rate is not known until the end of the calculation period). This initially caused some consternation among the credit community; however, the ARRC-recommend CME Term SOFR is forward-looking tenor of SOFR. Like LIBOR, there are different tenors of SOFR, including: • Fallback Rate (SOFR): a term adjusted SOFR plus a spread relating to USD LIBOR, published by Bloomberg Index Services Limited. Fallback Rate (SOFR) is a form of compounded SOFR in arrears. • CME Term SOFR: a daily set of forward-looking interest rate estimates calculated and published by CME Group in one-, three-, six-, and 12-month tenors. The use of CME Term SOFR is subject to certain licensing and other usage terms imposed by CME Group; however, under present usage terms, an end user1 seeking only to enter into a transaction using CME Term SOFR does not need a license from CME Group. Further, CME Group has waived fees for users of CME Term SOFR for cash transactions through 2026. Although LIBOR is a credit-sensitive rate and SOFR is a risk-free rate, they still generally trend together, except in rare periods of market disruption. To account for the “normal” difference based on a five-year historical median, the ARRC recommended spread adjustments in 2021, and the LIBOR Act includes spread adjustments corresponding to the different tenors of CME Term SOFR. Also in 2021, the ARRC published several recommended best practices for SOFR conventions in various types of loan transactions and for various tenors of SOFR. In selecting SOFR as the basis for the Board-selected benchmark replacements under the LIBOR Act, the Board asserts that it was guided by voluntary market practices, as in large part the loan market for cash (not derivative) transactions had already transitioned from LIBOR to Term SOFR. The Board’s selection of the SOFR-based replacement rates is intended to minimize market disruption. 17 Colorado Banker
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