Efforts underway in some jurisdictions to deal with the phase-out of LIBOR will not eliminate all of the uncertainties surrounding the transition away from the benchmark interest rate, in S&P Global Ratings' view.

Policymakers in the United States, the European Union, and the United Kingdom are seeking legislative solutions to address uncertainties about termination of LIBOR as a benchmark interest rate. Publication of one-week and two-month U.S. dollar LIBOR, along with sterling, euro, Swiss franc, and yen LIBOR, is scheduled to end on Dec. 31, 2021. Other LIBOR rates, including the overnight rate and more commonly used one-month, three-month, six-month, and 12-month U.S. dollar rates, are scheduled to cease after June 30, 2023.

These legislative efforts aim to reduce ambiguity about the interest rates to be used for individual contracts after LIBOR cessation where fallback provisions are absent, insufficient, or unclear. However, they are not a cure-all.

What Has Been Enacted and Proposed?

United States

In the United States, the state of New York enacted LIBOR transition legislation on April 6, 2021. Because New York law governs many financial contracts and most securitization bond documents, we think this legislation has significant potential to reduce uncertainty surrounding legacy contracts after LIBOR cessation. At a very high level, for New York law-governed financial instruments with no fallback provisions, or fallback provisions that result in a benchmark replacement based in some fashion on a U.S. dollar LIBOR value, or fallback provisions that call for interbank lending rate polling, the law provides for a new rate--referred to as the "recommended benchmark replacement"--to automatically (by operation of law) replace LIBOR at the appointed time. The recommended benchmark replacement will be a secured overnight funding rate (SOFR)--together with any spread adjustment--selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York, or the Alternative Reference Rates Committee.

Instruments with fallback provisions that point to a non-LIBOR-based replacement rate--such as the prime rate, the federal funds rate, or SOFR--are outside the scope of the law. Moreover, the law would not automatically impose the recommended benchmark replacement in cases where a "determining person"--such as a trustee or calculation agent--is authorized to pick a new rate, calculate interest payments based on a benchmark, or notify other parties of events relating to LIBOR discontinuance or replacement. That said, determining persons who select the recommended benchmark replacement benefit from a safe harbor against litigation. In addition, the law precludes parties from asserting breach of contract or refusing to perform their contractual obligations as a consequence of LIBOR's discontinuance or use of the recommended benchmark replacement.

While we view New York's new law as a significant step forward, it is no panacea. Its reach does not extend to LIBOR-based instruments governed by laws of other states or jurisdictions. Moreover, some legal experts have pointed out potential conflicts with a U.S. federal law, the Trust Indenture Act (TIA) of 1939, that applies to indentures for Securities and Exchange Commission (SEC)-registered public debt issues. Under the TIA, holders' rights to receive interest and principal payments cannot be impaired or affected without each holder's consent. For indentures subject to the TIA, to the extent New York's new statute "impairs or affects" holder payment rights, the TIA as a federal statute would presumably preempt that law.

The U.S. Congress is discussing legislation to address LIBOR transition at the federal level. A recently circulated discussion draft closely resembles the New York statute in various aspects including a SOFR-based replacement benchmark and litigation safe harbor. In addition, the proposal contemplates amending the TIA to clarify that the application of the federal LIBOR transition law will not "impair or affect" holders' rights. If enacted, the federal legislation would preempt New York's law and any other state LIBOR transition laws put into effect. A federal solution would be particularly beneficial for securitizations where many of the underlying LIBOR-based assets are governed by other state laws.

European Union

The European Union amended Benchmark Regulation (EU) 2016/1011 on Feb. 2, 2021, to give the European Commission the power to determine a replacement risk-free benchmark rate--together with a spread adjustment--for legacy contracts with no fallback provision or no "suitable" fallback provision. An unsuitable fallback provision is one where (i) a permanent replacement benchmark is not provided, (ii) consent is required from (and has been denied by) third parties, or (iii) the replacement benchmark doesn't reflect the underlying market or economic reality and could adversely impact financial stability. We expect this legislation will reduce legal uncertainty on some instruments that reference euro LIBOR, while being irrelevant to those that reference EURIBOR, which will remain outstanding.

United Kingdom

On April 29, 2021, the Financial Services Act 2021 was enacted to give the U.K.'s Financial Conduct Authority (FCA) enhanced powers to manage an orderly transition away from LIBOR benchmarks. Powers include:

• Prohibiting U.K.-regulated firms from using designated benchmarks from a specified date, but allowing the continued use of any newly prohibited benchmarks for those "tough" legacy contracts that stand little or no chance of being amended prior to LIBOR cessation.
• Designating certain benchmarks as critical, and requiring administrators of such benchmarks to change the benchmarks' methodologies (for example, to allow a change so LIBOR is no longer reliant on panel bank submissions and to allow it to become in effect a so-called "synthetic LIBOR").

The first power above applies only to U.K.-regulated entities, while the second power could have much broader impact.

Regarding synthetic LIBOR, the FCA says it intends in the second quarter of 2021 to consult the market on using its new powers to require continued publication of some sterling and yen LIBOR settings on a "synthetic" basis beyond their scheduled cessation dates. The FCA has also said it will continue to consider the case for taking similar action on some U.S. dollar LIBOR settings. We expect each synthetic LIBOR to be an alternative benchmark rate proposed by a central discussion body in each relevant market, such as the Alternative Reference Rates Committee in the U.S., with a fixed spread aligned with the relevant spread stipulated in the International Swaps and Derivatives Association's (ISDA) LIBOR fallback protocol. The U.K. legislation on synthetic LIBOR differs from U.S. and EU approaches in that it is not a statutory replacement of benchmark rates. Rather, it aims to effectively treat existing references to LIBOR as references to synthetic LIBOR. The authorized use of a synthetic LIBOR rate will be critical to minimize disputes between borrowers and lenders.

Importantly, these legislative solutions in the U.S., EU, and U.K. would address not only cash products but also derivative products. Parties to ISDA Master Agreements that have not adopted ISDA's recommended fallback language could be covered by such legislation. When ISDA adopts a protocol, it requires counterparties to sign up for the protocol. The legislative solutions above would in effect cover transaction counterparties that have not adopted the protocol.

Japan

In Japan, S&P Global Ratings is not aware of any proposed legislation to assist with LIBOR transition and believes this type of legislation is unlikely. Lack of legislative efforts here has raised Japanese market interest in synthetic yen LIBOR. However, it should be noted that, even if synthetic yen LIBOR is published, it will probably be available only for one year according to the FCA's March 5, 2021, announcement, and we expect details to emerge later in 2021.

Uncertainty To Remain

S&P Global Ratings expects these legislative solutions, if enacted, would reduce legal uncertainty as to what interest rate will be applied to an individual contract after the phase-out of LIBOR. However, they will not fully eliminate uncertainty around LIBOR transition.

Governing law and currency

The table below summarizes our understanding of the scope of the laws described above (with respect to governing law and currency of the contract referencing LIBOR).

Therefore, there may be some contracts that cannot benefit from legislation. For example, a bond would not benefit from any of these laws if both of the following conditions are met:

• The bond is issued or held by a Japanese entity and governed by Japanese law--making EU legislation nonapplicable, and
• The bond uses yen LIBOR and U.K. regulators decide not to introduce synthetic yen LIBOR.

What types of fallbacks can benefit from legislation?

The nature of outstanding fallback provisions is another factor that determines whether individual contracts benefit from any of these laws.

Regarding U.K. legislation on synthetic LIBOR, it remains to be seen what could result if non-U.K. transaction parties develop different preferences on the applicability of synthetic LIBOR. On Feb. 15, 2021, the U.K.'s HM Treasury proposed a legal safe harbor associated with the proposed U.K. legislation, but it explicitly stated at the same time that the U.K. can only provide a possible legal safe harbor for contracts governed by U.K. law.

Implications For Our Credit Ratings

Once the fallback outcome becomes available, we typically would consider the ratability of the promise to pay interest in accordance with our ratability standards, as described in paragraph 145 of "S&P Global Ratings Definitions."

We expect various alternative benchmark rates that have been proposed by central discussion bodies in each relevant market, such as the Alternative Reference Rates Committee in the U.S., will generally satisfy our ratability standard for floating interest rates.

We may need to assess the impact on ratings in some cases, particularly if interest rates on rated debt switch to an interest rate not based on any of the proposed alternative benchmark rates. For example, where the interest rate switches from LIBOR to a fixed rate, there may be a rating impact, particularly in the structured and project finance sectors.

We will continue to monitor the development of legislative efforts, the wording of outstanding fallback provisions for rated debt, and any efforts by parties to rated debt to amend such fallback provisions.