Legacy-Contract LIBOR-Replacement Benchmarks
Moving belatedly but now expeditiously to implement legislation governing legacy-contract benchmarks when there is no contractual fallback rate, the Fed has proposed a new framework for derivatives, consumer loans, certain GSE contracts, and any other legacy contracts without clear LIBOR-replacement provisions and a “determining person” to effectuate them. As required by the LIBOR Act, the new approach is SOFR-based and incorporates statutory “tenor spreads” designed to reflect the differences between a rate calculated with some amount of credit risk (LIBOR) to one premised on risk-free sovereign obligations (SOFR). The manner in which this was done was one of the most challenging aspects of finalizing the new law and reflects an uneasy compromise between the Fed and many in the industry, especially regional banks with large consumer-loan books. Perhaps due to the late date at which the proposal was issued, many other issues are not addressed, creating areas of potential uncertainty related to affected contracts and the broader body not only of Fed rules, but also the broader regulatory framework governing nonbanks.