The Financial Conduct Authority, the United Kingdom regulator
with the responsibility for overseeing LIBOR, announced in the
summer of 2017 that LIBOR would be phased out after the end of
2021. Since then, market participants and their respective advisors
have warned that the cessation of LIBOR should be a focal point for
the entire market. As a consequence, the Alternative Reference Rate
Committee ("ARRC") and now the International Swaps and
Derivatives Association ("ISDA") provided proposed
"fallback" protocols for adoption of an alternative rate
to LIBOR to facilitate a smooth transition away from LIBOR.
However, concern persisted that the change in the interest rate in
the applicable contract would cause a reissuance of the instrument
thus constituting a discharge of the existing contract and the
effectiveness of a new contract. In addition to the effect on bond
issues, the concern would also effect interest rate swaps and other
derivatives. The IRS provided initial proposed guidance on the
issue in
October 2019. Who knew at that time what 2020 would
bring? Industry groups persisted to bring awareness to the
potential impact on the capital markets so that almost exactly one
year following the prior proposed Treasury Regulation provisions,
the IRS released Rev. Proc.
2020-44. The new Revenue Procedure applies to modifications to
contracts entered on or after October 9, 2020 and before January 1,
2023. In addition, the Revenue Procedure can be relied upon
retroactively for modifications to contracts occurring before
October 9, 2020.
Rev. Proc. 2020-44 greatly simplifies the prior proposed
regulations by providing that any modification to a contract that
references an Interbank Offering Rate that is done to incorporate
an "ISDA Fallback," an "ARRC Fallback" or
either fallback with certain reasonably necessary deviations will
not result in a reissuance for tax purposes. A reissuance could
potentially result in unintended adverse tax consequences.
Borrowers and issuers should be aware the Revenue Procedure favors
a replacement of LIBOR with the Secured Overnight Funding Rate
("SOFR") plus adjustments for an applicable spread upon a
cessation of LIBOR. As a result, contract participants should be
sensitive to the use of rates other than SOFR (such as a prime
rate) and the implication additional changes falling outside the
safe harbor of Rev. Proc. 2020-44 may have on the obligation,
either upon amendment of existing debt and derivative contracts or
when entering into new agreements. Rev. Proc. 2020-44 does not
eliminate the need for conduit issuer involvement on certain
obligations so contract participants should additionally consider
with counsel the timing and procedures necessary to obtain conduit
issuer approval as applicable.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.