Improvements made in preparing leveraged loans for LIBOR demise, but more needed

Some improvement has been made in the remediation of leveraged loans as the deadline for termination of a widely used reference rate looms – but more progress is needed, a group that established an alternative rate said Wednesday.

In releasing minutes from its Feb. 9 meeting the Alternative Reference Rates Committee (ARRC), a group set up by the Federal Reserve and the Federal Reserve Bank of New York, said remediating leveraged loans has seen progress. It also noted that leveraged loans remains one of the key market segments that need to accelerate their transition away from the London Interbank Offered Rate (LIBOR), which is scheduled to disappear after June 30.

However, ARRC added that further progress is needed.

LIBOR, for most contracts, was no longer in effect following Jan. 1, 2022. However, for legacy contracts (that is, contracts still in effect then), LIBOR is scheduled to become defunct on June 30. Banks and others holding contracts using the rate have been advised to find an alternative rate. ARRC developed the Secured Overnight Financing Rate (SOFR) to be an alternative, which the Fed supports. However, the Fed and other federal financial regulators have not mandated use of SOFR – they have just advised their regulated entities to find a reference rate to replace LIBOR.

However, data provided at the meeting, ARRC said, indicated that SOFR is now predominant across cash and derivatives markets.

The ARRC said other issues discussed at its the Feb. 9 meeting included an update on its work on the Depository Trust Clearing Corp.’s (DTCC) LIBOR Replacement Index Communication Tool aimed at facilitating effective and efficient communication of rate changes in LIBOR contracts following June 30. “For U.S.-issued securities, ARRC said recommends that all determining persons, agents, and other parties responsible for disseminating information use this system for communicating rate/conforming changes.” Key points included:

  • The tool will move into production on Feb. 24. During the first day there will be a controlled number of notifications sent through the system.  These notifications will demonstrate that the system is fully functioning in an end-to-end fashion.
  • The first day of BAU is expected to be on Feb. 27.
  • The group also continues to collaborate with DTCC to create a centralized LIBOR transition site to house documents on how to use the new tool, FAQ’s and additional LIBOR transition background information.

In other action, the group discussed the risks associated with widespread use of Term SOFR outside of the limited and targeted recommendations suggested by the ARRC as best practice, which it said “have been carefully calibrated to ensure the robustness and sustainability of the rate itself and avoid risks to financial stability.”

The ARRC reiterated its existing best practice recommendations and plans to continue to assess the use of Term SOFR as part of its ongoing work related to Term SOFR’s recommended scope of use, it said.

ARRC Readout for February 9, 2023 Meeting