New York passes legislation imposing Libor-benchmark replacement

The New York state senate and assembly passed concurrent legislation Wednesday that would resolve how to reprice trillions of dollars of older, floating-rate financial contracts benchmarked to the outgoing U.S.-dollar Libor standard.

The legislation would impose a version of the Federal Reserve Bank of New York’s daily Secured Overnight Financing Rate benchmark rate on outstanding derivatives and securitization contracts, as well as corporate debt, currently pegged to U.S. dollar-Libor.

Under the proposal now awaiting New York Gov. Andrew Cuomo’s signature, contracts that lack so-called fallback language agreements on a Libor (or London interbank offered rate) replacement will convert to “recommended benchmark replacement” (currently SOFR) when Libor is no longer available after June 2023, or upon other market triggers for alternative-rate adoption.

The action aims to resolve the difficult problem of how to fairly compensate investors in which the contracted Libor rate is no longer available, and no amended agreement on a new rate is in place.

Capital-market and securitization industry groups, including the Fed-backed Alternative Reference Rates Committee working group, have been prepping for Libor’s demise for years, especially after a 2012 manipulation scheme involving several major global banks discredited the benchmark as an accurate measure of interbank lending and borrowing. (The rates have traditionally derived from bank quotes collected by the U.K.’s Financial Conduct Authority, rather than transactional activity.)

“The ARRC applauds the passage of its proposed legislation, which marks a major milestone in the transition away from LIBOR,” Tom Wipf, ARRC Chairman and vice chairman of institutional securities at Morgan Stanley, said in a statement. “Especially as we enter the home stretch for USD LIBOR, this legislation will address a key risk in the transition by providing a targeted solution for market participants who hold legacy contracts that have no effective fallbacks when LIBOR is discontinued.”

“The passage of the legislation is credit positive for structured finance transactions as well as other issuers lacking effective benchmark replacement language in their US dollar Libor exposures,” Jon Polansky, a managing director for Moody’s Investors Service, said in an email. “It will provide a fallback option for many contracts governed by New York law and legal safe harbors for parties that work on transitions to the new rate. Contracts governed by the state’s laws make up a material amount of Libor exposures in sectors such as the US structured finance market.”

The Securities Industry and Financial Markets Association, an ARRC member, also issued a statement of support for the legislation Thursday.

The New York legislation excludes Libor-based contracts with replacement rates already established, including SOFR, prime or federal-funds rates, according to the Loan Syndications & Trading Association.

The legislation is intended to target securitizations, mortgages and other long-term, legacy floating-rate products which were issued before Libor's cessation was announced and deal documents included no workable fallback language.

The New York legislation is less impactful for CLOs and syndicated loans, said Meredith Coffey, LSTA executive vice president and ARRC participant. The legislation would only affect the few CLOs that were issued prior to the second half of 2017, or those that didn’t contemplate LIBOR cessation (and would convert to a fixed-rate tied to a final published Libor rate), and will still be outstanding in June 2023. It’s not expected to affect syndicated loans because they typically can use prime if LIBOR is unavailable. "That was very intentional," said Coffey, "because no one wants to override a contract unless they have to."

Industry groups, including the ARRC, have lobbied Albany legislators for two years to introduce such legislation. The bills were set to be proposed in 2020 before the COVID-19 outbreak, according to Coffey.

Enacting change through at that state level is considered the most expedient method to amending wide-scale Libor-rate changes since many of the contracts drawn up via Wall Street are almost universally subject to New York law. Federal Reserve Chairman Jerome Powell has advocated national legislation through Congress, as well.

The ABS industry had faced a herculean task of readying for the demise of U.S. dollar Libor as soon as the end of 2021, the initial cutoff date the FCA has announced in 2017 as Libor’s global expiration across five currencies and seven tenors. But the ICE Benchmark Administration, the administrator of the Libor benchmark, announced March 5 it would delay the retirement of several of the most widely used U.S. dollar Libor benchmarks (including one-month and three-month) until mid-2023.

Regulars are pushing lenders and issuers against pricing new contracts with Libor, although new securitization offerings continue to roll into the ABS and structured-finance deal pipelines with Libor-linked deals.

While many asset-backed transactions and other financial instruments issued in the past three years have included provisions for replacing Libor when necessary, the New York legislation would require contracts lacking fallback agreements to adopt the SOFR benchmark being developed and promoted by the Fed-assembled ARRC, which is led by private-industry group members.

The ARRC this week estimated nearly $2 trillion of outstanding debt may fall into legal limbo due to the fact their maturities extend beyond Libor’s planned expiration in mid-2023.

Currently, the New York Fed publishes daily SOFR rates, which are slowly being adopted in new issuance of some asset-backed securities classes.