With US dollar LIBOR in its current form due to be discontinued on 30 June 2023, market participants are scrambling to transition as many of their remaining US dollar LIBOR referencing contracts over to alternative rates by that date. With so little time remaining, it is not surprising that a number of our UAE clients have been asking us recently, "can we just rely on Synthetic LIBOR instead?" This note explains the key points to bear in mind when considering this question.

What is Synthetic LIBOR?

It was estimated in 2021 that globally more than US$70 trillion of US dollar LIBOR exposures might remain outstanding beyond the planned cessation of US dollar LIBOR at the end of June 2023. Fast forward almost two years and, while many have already made great strides to transition their contracts away from US dollar LIBOR, a significant number of US dollar LIBOR contracts will undoubtedly remain at the end of this month. In anticipation of this, LIBOR's regulator, the Financial Conduct Authority (FCA), has:

• required the publication of one-, three- and six-month US dollar LIBOR settings (the Available Settings) on a synthetic basis from July 2023 until the end of September 2024 (Synthetic LIBOR) – this will be calculated as the aggregate of CME Term SOFR plus the ISDA fallback spread for the relevant Available Setting as published by Bloomberg in March 2021 (the ISDA Spread);
• permitted the entities it regulates to use Synthetic LIBOR in all existing contracts except cleared derivatives, but not in any new contracts; and
• designated Synthetic LIBOR as "non-representative" of the market that LIBOR has historically been intended to represent.

In addition, UK legislation has been introduced¹ under which any reference to LIBOR in an English law (or other UK law) governed contract will be interpreted as including any Synthetic LIBOR published under the FCA's powers – this will include Synthetic LIBOR in the Available Settings.

So, when will Synthetic LIBOR automatically apply?

Where an existing English law finance agreement:

• still uses one-, three- or six-month US dollar LIBOR; and
• provides that a specified fallback will apply if one of those LIBOR settings becomes unavailable,

that fallback will not be triggered at the beginning of the next interest period after 30 June 2023. The contractual references to LIBOR will automatically be read as including Synthetic LIBOR, and so "LIBOR" will remain available. However, if the same agreement also uses 12-month US dollar LIBOR, any contractual fallbacks would be triggered in respect of that rate after 30 June 2023 because there will be no 12-month Synthetic LIBOR. And, if the agreement provides that a specified fallback will apply if LIBOR becomes non-representative (rather than just unavailable), that fallback would again be triggered after 30 June 2023 – Synthetic LIBOR will be non-representative.

If the same finance agreement is governed by UAE law, the automatic application of Synthetic LIBOR is likely to be less certain. There is no legislation in the UAE equivalent to the UK legislation referred to above. So, where a UAE law contract refers to US dollar LIBOR, the question of whether that reference is broad enough to include Synthetic LIBOR will purely be a question of contractual interpretation.

How does this fit in with the US approach to tough legacy LIBOR contracts?

In the US, the Adjustable Interest Rate (LIBOR) Act 2021 has been passed at federal level to address tough legacy LIBOR contracts. It provides that on the first UK business day after 30 June 2023, references to LIBOR in any (in practice, US law governed) contract referencing LIBOR will automatically be replaced by the "Board-Selected Benchmark Replacement", but only if the contract:

• does not contain any fallback provisions; or
• only contains inadequate fallback provisions – broadly any fallback based on LIBOR (e.g. most recently published LIBOR) or that requires a person to obtain quotes in the market (e.g. reference banks).

Broadly, the "Board-Selected Benchmark Replacement" is compounded SOFR in arrear plus the relevant ISDA Spread for derivatives, and CME Term SOFR plus the relevant ISDA Spread for most other types of in-scope contracts.

The scope and effect of this US legislation will result in different outcomes for unamended US law governed contracts than equivalent English law contracts. However, derivatives aside, most types of in-scope US law governed contracts will transition to the same rate after 30 June 2023 through operation of law, as existing English law US LIBOR contracts will through automatic application of Synthetic LIBOR – in both cases, CME Term SOFR plus the relevant ISDA Spread will apply.

Should parties rely on Synthetic LIBOR?

Even where it is clear that Synthetic LIBOR will automatically apply to an unamended existing LIBOR contract after 30 June 2023, parties may not always want to rely on it. In particular:

• using Synthetic LIBOR automatically locks in use of the ISDA Spreads. Some corporates have successfully negotiated lower credit adjustment spreads when transitioning their LIBOR facilities over the last 18 months and others may still seek to do so;
• if the contract in question is expected to continue to run after 30 September 2024, the parties are likely to need to replace references to LIBOR in the contract at some point – there is no expectation that Synthetic LIBOR will continue to be published after that date; and
• Synthetic LIBOR is very much a basic safety net. Parties may feel more comfortable updating their documents to include all the latest Term SOFR fallbacks and related terms – in particular, now that the LMA has published recommended forms of Term SOFR facility documentation.

Synthetic LIBOR is not a perfect solution and certainly not a permanent one. However, it may provide a helpful transitional resource to enable parties to focus their resources now on LIBOR contracts where its application may be less certain – such as those governed by UAE law.

If you have any queries on the above or require assistance from our Banking and Finance team, please contact us.

This article is also available in Arabic, click here to download.

1. The Critical Benchmarks (References Administrators' Liability) Act 2021, amending the Benchmarks Regulation (EU) 2016/11 as incorporated into UK domestic law. ↩