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U.S. Federal Reserve issues final rules on replacement rates for USD LIBOR contracts

The Board of Governors of the U.S. Federal Reserve adopted final rule 12 CFR Part 253 “Regulation Implementing the Adjustable Interest Rate (LIBOR) Act” (Final Rule) in December of last year (16th December 2022). This Final Rule supplements the US Adjustable Interest Rate (LIBOR) Act (US Act) and created statutory replacement rates that will apply to certain US contracts and instruments once the existing USD LIBOR tenors are discontinued as of the 30th June of this year (2023).

We’ve taken the liberty of highlighting the benchmark replacement rates for you in the following bitesize summary:

The US Act (Section 253.4 of the Final Rule) provides that a “board-selected benchmark replacement” will substitute overnight, one-month, three-month, six-month and twelve-month USD LIBOR in contracts and instruments (governed by U.S. Law) in respect of which the “determining person” has not determined a suitable replacement rate or those that do not include effective fallbacks. The US Act places the responsibility of determining the replacement benchmark with the Federal Reserve Board (the Board). The Final Rule formally adopts the following replacement rates that were initially proposed in July 2022:

  1. for derivative transactions, the replacement will be the one identified as the ISDA’s Fallback Rate (Secured Overnight Financing Rate – SOFR), being the rate published by Bloomberg. It is calculated based on SOFR compounded in arrears plus the relevant Bloomberg spread (each such spread being specified in the Final Rule).

It is worth noting that varying replacement rates for cash products and related derivative hedging transactions may lead to basis risk. However, in its consideration, the Board noted that parties that are involved in these transactions of this nature are experienced managers and as such are well versed in managing hedging risk. Additionally, there is nothing in the Final Rule that restricts parties from deciding on a more suitable rate;

  1. for transactions that are not derivative transactions and are neither consumer loans nor contracts to which government sponsored enterprises are party, the replacement rates are:
  • for contracts referencing overnight USD LIBOR – SOFR plus the relevant Bloomberg spread; and
  • for contracts referencing one-month, three-month, six-month or twelve-month USD dollar LIBOR, CME Term SOFR plus the relevant Bloomberg spread.

If you would like more information about the Final Rule, we recommend that you reach out to your US legal counsel or tax advisor.

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