U.S. Regulators to Leveraged Loan Issuers: Just Do It (Transition to SOFR)
In late 2020, U.S. regulators [i] issued supervisory guidance encouraging banks to stop entering into new financial contracts that reference U.S.-dollar-denominated Libor (the London Interbank Offered Rate). The regulators set a deadline of 31 December 2021 to transition all contracts away from Libor. They also indicated that any Libor-referenced contracts in the interim should have a robust fallback with a clearly defined alternative rate. The statement from the regulators applied to all financial contracts that reference Libor, implicating leveraged loans, a floating-rate sector that has long used Libor.
Since 2017, the Alternative Reference Rate Committee (ARRC) – a group of market participants (including PIMCO) convened by the Federal Reserve Board and the New York Fed – has recommended that the Secured Overnight Financing Rate (SOFR, a reference rate published by the New York Fed) replace USD Libor. The ARRC also recommended “hardwired” fallback language be used in both syndicated and bilateral loans beginning in the autumn of 2020, and that banks stop originating Libor-referenced leveraged loans after 30 June 2021.
Yet, despite prompts from regulators and market participants, the U.S. leveraged loan market has been slow to embrace SOFR, even while other fixed income sectors issue new SOFR-referencing contracts. This lack of progress has most recently caught the attention of U.S. Treasury Secretary Janet Yellen, who noted that loans are well behind where they should be at this stage in the transition. We believe continued delay could elevate risks for both loan issuers and investors during the delicate transition away from Libor.