By The Star Staff
The transition on June 30 from the London Inter-Bank Offered Rate, known as Libor, to the Secure Overnight Financing Rate, or SOFR, for loans and credit products could impact some of the debt transactions already approved by the Financial Oversight and Management Board.
For more than 40 years, the Libor was a key benchmark for setting the interest rates charged on adjustable-rate loans, mortgages and corporate debt. Libor provided loan issuers with a benchmark for setting interest rates on different financial products each day by collecting estimates from up to 18 global banks on the interest rates they would charge for different loan maturities, given their outlook on local economic conditions. Libor was calculated in five currencies: the UK pound sterling, Swiss franc, euro, Japanese yen and U.S. dollar.
However, Libor is being phased out in large measure because of the role it played in worsening the 2008 financial crisis, as well as scandals involving Libor manipulation among the rate-setting banks.
SOFR will replace Libor in the United States. SOFR uses a benchmark based on the rates U.S. financial institutions pay each other for overnight loans.
Those transactions take the form of Treasury bond repurchase agreements, otherwise known as repos agreements. They allow banks to meet liquidity and reserve requirements, using so-called Treasurys as collateral. SOFR comprises the weighted averages of the rates charged in repo transactions.
However, the change will have an impact on some of the debt transactions in the event the banks involved decide to change the interest rate, according to a review from the oversight board.
In response to inquiries from Omar Marrero Díaz, executive director the Fiscal Agency and Financial Advisory Authority, the oversight board found that the transition will impact some debt transactions already approved.
Robert Mujica, the oversight board’s executive director, replied in writing Tuesday that the oversight board expects three different interest rate transition scenarios, depending on the contractual provisions governing the transaction.
Those scenarios are transactions that will automatically transition from Libor to SOFR by operation of law, transactions where a fallback interest rate is provided in the transaction’s legal documentation and will be applicable prospectively, and transactions where the financial institution involved in the transaction is willing to offer an interest rate lower than the fallback interest rate notwithstanding the transaction’s legal documentation.
It is the oversight board’s position that the first two scenarios previously stated do not constitute a modification of the debt transaction.
“The third scenario, however, would constitute a modification of the debt transaction, given that the financial institution involved in the transaction would be voluntarily offering a new interest rate not dictated by either statute or previously agreed terms or conditions,” Mujica wrote. “Therefore, such change to the transaction’s terms or conditions shall be deemed a modification of the debt transaction.”
As such, the oversight board said documentation related to transactions falling into the third scenario stated above must be submitted to the oversight board for review.