The Alternative Reference Rates Committee (ARRC) today released recommended contractual fallback language for U.S. dollar (USD) LIBOR denominated bilateral business loans and securitizations. This follows the release of the ARRC’s recommended contractual fallback language for floating rate notes and syndicated loans in April. These provisions are for market participants’ voluntary use in new contracts that reference LIBOR and were developed with the goal of reducing the risk of serious market disruption in the event that LIBOR is no longer usable.
These recommendations are part of the ARRC’s mandate to help address risks in contracts referencing LIBOR. They build on the ARRC’s work to develop the Paced Transition Plan, which outlines the steps for an effective shift to the ARRC’s recommended alternative reference rate, the Secured Overnight Financing Rate (SOFR). The ARRC also expects to consult with a broad range of stakeholders on proposals for fallback language in consumer products in the future.
“It is imperative that market participants stop writing contracts that do not account for the discontinuance of LIBOR. Both today’s fallback language and the set issued last month provide essential tools for writing robust contracts,” said Tom Wipf chair of the ARRC and Vice Chairman of Institutional Securities at Morgan Stanley. “It’s time that all market participants transition their products away from U.S. dollar LIBOR where possible and we encourage the use of SOFR now, but those that continue to use LIBOR need to make sure they have very strong fallbacks in place.”
The final recommended language was prepared after consideration of all comments received—over 50 in total—on the fallback language consultations for bilateral business loans and securitizations. These provisions were endorsed by the ARRC and represent a consensus of its Business Loans and Securitizations working groups. Together, these working groups represent the collective work of more than 80 institutions and trade groups, including more than 300 individuals. Cadwalader, Wickersham & Taft LLP assisted the working group efforts as drafting counsel.
As described in the ARRC’s guiding principles for fallback language, there are substantial benefits to aligning fallback provisions across different products so that they would operate similarly in the event that LIBOR is no longer usable. Recognizing, however, that financial products differ in critical ways, the ARRC’s recommended fallback language is designed for specific products but seeks general consistency in defining key terms, including:
- Benchmark Transition Events: the trigger events that start the transition away from LIBOR;
- Benchmark Replacement: the successor adjusted rate that would replace references to LIBOR throughout the contract following a Benchmark Transition Event; and
- Benchmark Replacement Adjustment: the spread adjustment component of the Benchmark Replacement that is applied to the successor rate to make it more comparable to LIBOR.
Bilateral Business Loans
Similar to the ARRC’s recommended fallback language for syndicated loans, the recommended language for bilateral business loans includes two different approaches: a “hardwired” and an “amendment” approach.
Hardwired Approach: This approach provides a clear waterfall for selecting a replacement benchmark and spread adjustment that would apply if LIBOR is no longer usable.
- Amendment Approach: This approach provides a streamlined amendment mechanism that offers flexibility in selecting a replacement benchmark and spread adjustment.
The fallback language also provides an option that acknowledges the relationship between loans that implement a replacement benchmark and related hedging arrangements that borrowers and lenders use to mitigate risks.
Securitizations
The ARRC’s recommended fallback language for securitizations proposes a hardwired approach regarding triggering events and the waterfall for rate determination. It also addresses the unique challenges presented by the securitization market’s asset and liability components.