LIBOR to SOFR Conversions

On March 15, 2022, President Biden signed the Omnibus Spending Bill which contained the Adjustable Interest Rate (LIBOR) Act.

This was to deal with the estimated US$15 trillion worth of existing "tough legacy" LIBOR contracts. A "tough legacy" contract is a contract that does not: (a) specify a replacement for LIBOR or (b) contain an adequate LIBOR replacement mechanism. These contracts create the specter of substantial litigation as they rely on a rate that will cease to be in existence after June 30, 2023.

The federal legislation addresses this issue by permitting the Board of Governors of the Federal Reserve System to select a Secured Overnight Financing Rate (SOFR)-based replacement for LIBOR in tough legacy contracts, which will replace LIBOR by operation of law. In doing so, the federal legislation ensures that these tough legacy contracts will continue to have an applicable active rate.

In addition, the federal legislation also creates a "safe harbor" for eligible persons (with the ability to select a benchmark replacement under the terms of a contract) who select a SOFR-based LIBOR replacement.

The bill's "safe harbor" states that no eligible person will be subject to legal liability arising out of their selection of a SOFR-based replacement for LIBOR. Likewise, the bill also insulates from legal liability eligible persons who implement contract "conforming changes" that are necessary to effectuate the transition away from LIBOR. An example of a protected "conforming change" would be replacing a contract's references to LIBOR with SOFR. A late change to the federal legislation also created a narrow safe harbor for banks that had previously selected a non-SOFR-based LIBOR replacement. The legislation specifies that no supervisory agency may take action against a bank solely because of its selection of a non-SOFR LIBOR replacement.

While earlier versions of the federal LIBOR legislation stated that modifications to contracts for the purposes of transitioning away from LIBOR would not constitute a taxable sale or exchange, the final passed version of the bill omitted such language. However, on January 4, 2022, the Internal Revenue Service issued final regulations regarding the LIBOR transition, "Guidance on the Transition from Interbank Offered Rates to Other Reference Rates" (Final Regulations; 87 FR 166). The Final Regulations indicated that a modification to an existing contract solely to replace LIBOR would not constitute a taxable event so long as certain government-recommended tenor-adjustment spreads were used. These government-recommended tenor-adjustment spreads seek to keep contracting parties in an equivalent economic position (i.e. the spreads ensure that neither party is unfairly benefited nor burdened by the replacement of LIBOR)

The Federal Reserve adopted Regulations implementing the Adjustable Rate (LIBOR) Act on January 26, 2023.