By Daniel Casey
What could be more titillating in
the middle of a gorgeous Boston summer than…yes…a review of recent developments
relating to LIBOR. Most of our lender and borrower clients know that LIBOR
For many years, LIBOR, as a
reflection of the cost of money charged among those thought to know the most on
the subject, was considered to be a stable index and an accurate reflection of
the health of the financial system in major world markets.
LIBOR is essentially an interest
rate average calculated daily based on the rates large, international banks
based in London charge each other for short term inter-bank loans. LIBOR rates
are published daily in five different currencies and for seven borrowing
periods ranging from overnight to one year, and are typically aggregated with a
margin for purposes of calculating the interest rate applicable from time to
time under credit facilities indexed to LIBOR.
For many years, LIBOR, as a
reflection of the cost of money charged among those thought to know the most on
the subject, was considered to be a stable index and an accurate reflection of
the health of the financial system in major world markets. In theory, when
times are good and LIBOR reporting banks feel more confident about the health
of the world’s financial system, those banks report a lower inter-bank lending
rate; and when times worsen and confidence weakens, those banks report a higher
inter-bank lending rate.
Either way, rates reported by LIBOR
reporting banks for inter-bank loans are supposed to be the actual rates those
banks charge each other, in order to provide an accurate reflection of the
actual health of the financial system. Unfortunately, dating back at least two
decades, certain LIBOR reporting banks began to manipulate LIBOR by
fraudulently reporting hypothetical inter-bank lending rates, primarily to
hedge against impending fears in derivatives markets. Although these banks were
able to hide their often collusive activity for decades, by 2014 many of those
banks operating in the United States had been prosecuted and held accountable
for illegally manipulating LIBOR.
Although confidence in the
integrity of LIBOR as a world interest rate benchmark subsequently diminished,
many banks operating in the United States continued to rely upon LIBOR as an
index of choice in pricing variable rate loans, inserting into their promissory
notes fairly generic rate substitution language which would apply in the event
LIBOR ceased to be published during the term of the loan. However, in late
2014, as concerns over LIBOR manipulation deepened, the Federal Reserve Board
and the Federal Reserve Bank of New York (collectively, the “Fed”), announced
the creation of the Alternative Rates Reference Committee (“ARRC”) to assess
the continued integrity of LIBOR and a viable replacement index. Recently, ARRC
recommended the discontinuation of LIBOR as a published rate index, and the Fed
adopted that recommendation to become effective no later than the end of 2021.
The discontinuance of LIBOR will
affect any loan in place at the time publication of LIBOR ceases.
Unfortunately, the generic index substitution language that made its way into
many existing promissory notes following early concerns over LIBOR’s continued
viability are now considered to be inadequate for purposes of assuring an
accurate and meaningful replacement of LIBOR as the index applicable to those
loans. Accordingly, most banks are implementing procedures not only to modify
documentation of new loans, but also to seek modification of existing loans, to
include LIBOR replacement provisions consistent with the actual LIBOR
substitution policies adopted by the Fed.
While the intention of any index
substitution provision – either existing generic provisions or new provisions
intended to reflect the Fed’s replacement policies – is to provide an
applicable borrowing rate reasonably equivalent to the rate which would have
resulted under the original index, any proposed index replacement –
particularly one arising in connection with a requested loan modification –
should be carefully reviewed by both lender and borrower. MTM is available to
assist our lender and borrower clients with any proposed LIBOR rate
substitution in an efficient and informed manner.
Dan is Of Counsel to Braintree and
Boston based law firm of Moriarty, Troyer & Malloy LLC, representing
buyers, sellers, investors, developers and lenders in the acquisition,
financing, development, leasing and disposition of real estate across every
asset class. Dan can be contacted by email at dcasey@lawmtm.com.
