WASHINGTON — Consensus is building among banks and regulators that federal legislation will be required to avoid uncertainty and liability issues related to the yearslong transition away from the scandal-plagued London interbank offered rate.
Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen recently told lawmakers that Congress should pass a bill to provide automatic fallback language for trillions of dollars' worth of legacy contracts that would automatically swap in a new rate when most Libor settings end in 2023.
Without congressional action, regulators and industry groups fear that courts could be quickly swamped with litigation between contract issuers and buyers.
“While Libor is ending, and while parties to bilateral contracts should start amending or taking actions to address what's going to happen in the future, there are some situations where it's just impossible to do that, and that's where the legislation needs to come in and help solve that issue,” said Amy Williams, a partner at Hunton Andrews Kurth and co-leader of the firm’s Libor transition team.
The push for federal legislation comes as the New York state legislature on Wednesday passed a measure to be included in the state’s budget that would cover a large majority of Libor legacy contracts, though not all of them.
The New York legislation was developed by the Alternative Reference Rates Committee — a group of private-market participants formed under the auspices of the Federal Reserve Bank of New York — and would automatically insert the Secured Overnight Financing Rate as a fallback rate in legacy contracts for which no other viable fallback rate is named. The inclusion of SOFR, the committee’s recommended replacement for Libor, in those contracts could “minimize legal uncertainty,” the proposal said.
But it would ultimately be preferable to have a federal law in place to provide as much consistency as possible, said Lary Stromfeld, a partner at Cadwalader and member of the ARRC.
“Having [legislation] done in New York is very, very important and would be a huge help to the market, because so many commercial transactions are governed by New York law," Stromfeld said. "But there are still a lot of transactions that are governed by other state laws, and so having a law that covers all states and that's consistent across all states is also very, very valuable."
Yellen for the first time earlier this week said she agreed, telling Rep. Brad Sherman, D-Calif., during a March 23 hearing in the House Financial Services Committee that there are certain legacy contracts “where the transition could be difficult without legislation.”
“These are contracts that don't provide for workable fallback rate, and so I think Congress does need to provide legislation for the Libor transition,” Yellen said.
Powell
Powell's comments — along with a recent speech from Fed Vice Chair for Supervision Randal Quarles, in which he warned that regulators
“I think that the Fed's increasing involvement here, to us at least indicates that there's an interest at the federal level in reaching a resolution of this and getting some stability and predictability in the market,” he said.
The ARRC and other industry participants also see a need for federal legislation to address an obscure law, the 1939 Trust Indenture Act. That law prohibits amending securities without getting the consent of all investors involved. Achieving that for all affected legacy contracts is “in many cases, just impractical, perhaps impossible,” Williams said.
State legislatures cannot amend a federal law, so even if New York were to enact legislation addressing the transition, some form of federal guidance could still ultimately be necessary.
“The federal law [could] say, notwithstanding that previous federal law, notwithstanding what's in the contract, you can do this, and it won't impair people's rights, and there's a safe harbor from litigation too,” Williams said. “That's what's really important.”
It remains unclear if and when Congress might be able to pass a bill to ease the transition, though most agree that the legislation is relatively uncontroversial.
“I don't see this as a particularly partisan-type issue,” Libra said. “I think, generally speaking, most folks are interested in there being some kind of a predictable and certain decision on this that folks can implement.”
Sherman
“I think the original intention was, 'Get New York, and then go after other states so maybe they would copy,' " Williams said. “Now, there is some real hope that we can get a federal solution. I think people are still pursuing the New York one … but now there's real hope that the new administration and Congress, especially with the Fed chairman getting behind it, that we may actually get a federal solution that would solve this.”
The more regulators and bankers that publicly support a federal legislative solution, the better, said Emilio Jimenez, managing director at JPMorgan Chase and co-chair of the ARRC's legal working group.
“I think it's really important that Chairman Powell and Vice Chair Quarles have come out with a public statements to that effect,” Jimenez said.
Williams said she hopes that others will “join the rallying cry” and that Congress will pass something this session so that issuers are granted as much certainty as possible before the 2023 expiration date.
“I think people have been distracted with bigger issues, trying to get [through] what they perceive as bigger issues, and the new administration trying to get through the COVID package, etc.,” she said. “So maybe now that that has pushed off, they'll turn to some important things that we've got to get solved at some point.”
