WASHINGTON – Banks and regulators agree that federal legislation will be needed to avoid uncertainty and liability issues related to years of transition from the scandal-ridden London interbank supply rate.
Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen recently told lawmakers that Congress should pass legislation to provide automatic fallback language for $ trillion-worth of legacy contracts that are automatically closed would change course when most Libor recruitment ends in 2023.
Treasury Secretary Janet Yellen and Federal Reserve Chairman Jerome Powell recently joined calls for federal legislation to ease the Libor transition, due to expire in 2023.
Without action by Congress, regulators and industry associations fear that courts could quickly become inundated with litigation between contract issuers and buyers.
“While Libor is ending and the parties to bilateral treaties should change or take action to regulate what will happen in the future, there are some situations where it is simply impossible and this is where legislation needs to be put in place to help solve this problem said Amy Williams, partner at Hunton Andrews Kurth and co-lead of the company's Libor transition team.
The pressure on federal legislation comes as New York lawmakers on Wednesday passed a measure to be included in the state budget that will cover a large majority, if not all, of legacy Libor contracts.
The New York legislation was developed by the Alternative Reference Rates Committee – a group of private market participants formed under the auspices of the Federal Reserve Bank of New York – and would automatically include the Secured Overnight Financing Rate as the fallback rate in legacy contracts for which no other feasible fallback rate is called. The inclusion of SOFR, the replacement for Libor recommended by the committee, in these contracts could "minimize legal uncertainty," the proposal says.
Ultimately, however, it would be preferable to enact federal law to ensure as much coherence as possible, said Lary Stromfeld, a partner at Cadwalader and a member of the ARRC.
"Having [legislation] in New York is very, very important and would be of great help to the marketplace since so many commercial transactions are governed by New York law," Stromfeld said. "But there are still a lot of transactions that do this." are governed by other state laws, so it's very, very valuable to have a law that covers all states and is consistent across all states. "
Yellen said she agreed for the first time earlier this week, telling Rep. Brad Sherman, D-Calif., During a March 23 hearing on the House Financial Services Committee that there are certain legacy contracts “that transition without legislation could be difficult. ”
"These are contracts that don't have a workable fallback rate, so I think Congress needs to propose laws to transition the Libor," Yellen said.
Powell told lawmakers in February that "federal legislation that creates a path for backup would be the best solution" to address the move to a new benchmark.
Powell's comments – along with a recent Fed vice chairman speech to Randal Quarles warning that regulators are ready to punish banks using Libor on new contracts after this year – should help draw attention to it the transition and the need to direct legislation, said John Libra, an attorney with Korein Tillery.
"I think the Fed's increasing engagement here, at least for us, suggests that there is a federal interest in finding a solution to this and achieving some stability and predictability in the market," he said.
The ARRC and other industry stakeholders also see the need for federal legislation to address an obscure law called the Trust Indenture Act of 1939. This law prohibits the modification of securities without the consent of all investors involved. Achieving this for all affected old contracts is "in many cases only impractical, perhaps impossible," said Williams.
State law cannot change federal law. Ultimately, even if New York were to legislate to combat transition, some form of federal directive might be required.
"Federal law [could] say, regardless of previous federal law, regardless of what's in the contract, you can do this, and it won't harm people's rights, and there's a safe haven from litigation, too," Williams said . "That's what really matters."
It remains unclear if and when Congress might be able to pass legislation to ease the transition, although most believe the legislation is relatively undisputed.
"I don't see this as a particularly party-political problem," said Libra. "I think in general most people are interested in that there is a predictable and safe decision that people can implement."
Sherman is reportedly working on a bill that will reflect the bill tabled by the ARRC and passed by New York State legislature on Wednesday. His office did not respond to requests for comment.
"I think the original intent was, 'get New York and then go to other states so they might copy them,'" said Williams. "Now there is real hope that we can find a federal solution. I think the people are." I'm still chasing New Yorkers … but now there is real hope that the new administration and Congress, especially with the Fed chairman, are behind it, that we actually get a federal solution that would solve this. "
The more regulators and bankers publicly support a federal legislative solution, the better, said Emilio Jimenez, executive director at JPMorgan Chase and co-chair of the ARRC's legal working group.
"I think it's really important that Chairman Powell and Vice-Chairman Quarles made public statements about this," said Jimenez.
Williams said she hopes others will "join the hunt group" and that Congress will pass something at that session so that issuers are given as much security as possible before the 2023 expiration date.
"I think people have been distracted by bigger problems and trying to get through what they perceive to be bigger problems and the new administration has been trying to get through the COVID package etc," she said. "Maybe now that this has been pushed off, they turn to some important things that we have to resolve at some point."