Lawyers write the future for $200tn of post-Libor deals
Lary Stromfeld, a senior lawyer at Cadwalader, Wickersham & Taft in New York, has spent much of his working life dealing in big numbers. Still, the $200tn stakes in his latest project took matters to a new level — even for him.
That project was to help the US Federal Reserve guide the massive financial institutions it supervises to a future without the London interbank offered rate. Libor is the interest rate that underpins the terms of some $200tn of dollar-denominated derivatives, loans and bond contracts, but which regulators have decided to replace.
“The first thing we had to do was . . . stop digging,” says Stromfeld. “Markets had to clearly address the fact that Libor would be going away.”
Regulators had given Libor a death sentence in 2017, declaring it too marred by scandal and manipulation to continue as a foundation of the world’s financial system. That cut-off date has since shifted and now stands at June 2023, with US regulators saying no new deals are to be tied to Libor from 2022.
Stromfeld and his team drafted documentation that could be used during the interim “where they [financial institutions] were continuing to transact on the basis of Libor but . . . contemplated the end of Libor”. The aim was that the same formulation of words could be used to update old contracts that had “bad language or no language” about Libor.
The wording was a challenge, Stromfeld says. While lawyers knew Libor was ending imminently, they did not know key details such as accrual periods and compounding conventions for the operation of its proposed replacement: the secured overnight financing rate, or Sofr. This is based on the average rate of market transactions. Libor’s many and varied uses also complicated the task.
“It’s not like we could come to the market and say . . . this works for everyone,” recalls Stromfeld. Instead, his team developed language that could be tailored by markets linked to Libor, such as that for collateralised loan obligations.
“We worked with all of those markets,” says Stromfeld, describing a process where the team asked those involved in individual markets what they needed and what language they wanted to use for that. The result was a mishmash of approaches that would be “very confusing” for investors trying to navigate the new landscape. Cadwalader’s task was to harmonise them as far as possible.
“We had to convince the people who had spent all this time developing and thinking about their markets and their standards, who are experts . . . that ‘this is what we think you should do’,” Stromfeld says of his task. “It took a high degree of explanation. They had to be very confident in what we were telling them.”
Tom Wipf, a senior executive at US bank Morgan Stanley, who chairs the Fed’s Alternative Reference Rates Committee — the industry body to lead the shift from Libor — believes Stromfeld and his team played an “instrumental role” in the transition. He says the lawyers developed legislation that will be “critical in minimising operational and legal risks for market participants who hold legacy contracts that have no effective fallbacks for Libor’s cessation”.
To do this, Stromfeld enlisted the help of more than 100 lawyers from across the firm, in areas that included securitisation and lending, and produced wording designed to future-proof new contracts for life after Libor. The wording is now recommended for use, though not required, by the Fed. Stromfeld regards that as a significant accomplishment, since the “large majority” of the Libor contracts outstanding in June 2023 will now have “robust language” to carry them through to the new benchmark.
Still, the numbers for Libor are so big that the rump is large. The market’s estimate of $200tn of dollar-denominated Libor contracts today includes $90tn that will still be in force by June 2023. If just 10 per cent of those do not have robust Libor transition provisions, that is still a $9tn problem.
Stromfeld comments that the nature of the contracts outstanding means there is a “higher risk of disruption” if provisions are not put in place for them.
A major problem is the US Trust Indenture Act, which prohibits amending the principal or interest terms of a debt instrument without 100 per cent agreement from investors. That makes it “impossible as a practical matter” to amend the terms of anything with a broad investor base, Stromfeld notes.
“We had to change the law,” he says. His team developed new legislation that would enable contracts to be modified by “operation of law” without consent. The legislation has been enacted in New York and is working its way through Congress. Stromfeld says there is a “strong expectation” that it will go through smoothly since it has bipartisan support.
Arguably, the new legislation would override the need for the original work that Stromfeld and his team undertook in future-proofing contracts written between now and 2023.
“You could [argue that], but there’s a strong preference in the US by both regulators and market participants to not be forced into doing things,” he says.
Once the legislation is through, Stromfeld’s regulatory work on the transition will be largely complete and he will switch to advising financial institutions on how to manage their portfolios between now and June 2023. “Institutions are continuing to remediate their portfolios,” he says.
“The legislation I described is really just a safety net if you fail to do anything. You don’t want to rely on it — it’s a seatbelt in case you crash into the wall.”
Case studies: creating new standards; digital legal practice
Researched, compiled and ranked by RSGI. ‘Winner’ indicates the organisation won an FT Innovative Lawyers 2021 award
Creating new standards
WINNER: Cadwalader, Wickersham & Taft
Following the UK Financial Conduct Authority’s announcement in 2017 that the London interbank offered rate (Libor) would be phased out by 2022, the firm advised the US Federal Reserve’s Alternative Reference Rates Committee, which is responsible for managing the transition to the new secured overnight financing rate (Sofr).
Lawyers at the firm found that potentially trillions of dollars were at risk in deals held in contracts that could not be amended to include Sofr. The firm helped design and campaign for legislation that clarifies that where “Libor” is written in a contract it should now be read as “Sofr”. This law passed in New York state in April and is under consideration to become federal law.
Cravath, Swaine & Moore
Using its expertise in dealing with the US Securities and Exchange Commission and complex initial public offerings, the firm helped fintech company Robinhood launch its IPO in a way that was consistent with its mission to “democratise finance for all”.
Robinhood made 35 per cent of the shares available to its users via its app — a higher proportion than usually allocated to retail investors, though many did not take up the offer. The lawyers helped Robinhood through the process, using the app and marketing the IPO through a live-streamed virtual roadshow.
Creel, García-Cuéllar, Aiza y Enríquez
Mexico has a growing fintech market, with the potential to make a significant impact, given that some 40m people in the country do not have a bank account. The firm is advising fintech businesses, including Credijusto on its acquisition of Banco Finterra, the first time a technology company has acquired a licensed bank in Mexico.
The firm also advised on a joint venture between bank Banorte and fintech company Rappi that enables Rappi to offer Banorte’s products via its mobile app.
Investment company Franklin Templeton created the OnChain mutual fund, a money-market fund that uses blockchain to store and transact share data. Dechert lawyers used their experience working with the US Securities and Exchange Commission and financial institution and fintech start-up clients to help Franklin Templeton secure regulatory approval for the fund in April 2021.
The lawyers argued that trading instantaneously through a distributed ledger reduces the risks and fees associated with using intermediary banks to settle payments.
Partner Andrew Serwin was a key witness in an Irish high court case concerning the privacy and security of personal data being transferred between EU countries and the US. This case, Schrems II, followed the European Court of Justice opinion in 2015 that safeguarding measures for EU data transfers to the US were inadequate (Schrems I).
Serwin’s commentary on US national security law around data surveillance helped convince the Irish and European courts that the safeguarding measures put in place after Schrems I were still inadequate. Now, businesses must assess whether data they are transferring could fall under the legal purview of US national security surveillance, and in that case include additional protections in contracts such as localising data in an EU country.
On the request of drugs company Novartis, the firm worked with CMS, the US federal agency that manages Medicare and Medicaid healthcare services, to develop a model for pricing experimental gene cell therapies. These treatments tend to have higher upfront costs and, initially, more uncertain clinical outcomes.
Lawyers in the firm’s global regulatory practice designed a model that links a drug’s price to its long-term performance. This enables pharma companies to provide varying prices to Medicaid programmes, tied to how these treatments perform in practice.
The firm’s public policy practice has been working with clients in emerging industries to lobby at state level. These include sports-betting companies such as FanDuel and DraftKings to obtain licences to operate mobile apps, since the federal ban on sports betting ended in 2018.
Combining the skills of government affairs professionals and lawyers to lobby state lawmakers, the practice helps clients build grassroots support for their legislative agenda. It also works with interest groups, such as Native American tribal leaders and sports leagues.
Paul, Weiss, Rifkind, Wharton & Garrison
Swiss bank Credit Suisse faced $5.5bn in losses from the Archegos scandal, in which the family office defaulted on its margin payments to investment banks. The bank hired Paul, Weiss to run its internal investigation, resulting in a report that identified key individuals responsible, as well as cultural and procedural issues. The report has enabled regulators and other banks to apply the lessons to their risk-management procedures.
Digital legal practice
WINNER: Wilson Sonsini Goodrich & Rosati
The firm has merged its platform for managing start-up employee stock holdings with investment bank Morgan Stanley’s version of this technology, called Shareworks. Wilson Sonsini clients that elected to transfer their data to Shareworks received a discount and access to additional Morgan Stanley services. The partnership gives the bank access to more clients and gives the law firm proprietary access to Shareworks, also allowing Wilson Sonsini to integrate Neuron, its legal process and automation system, with the platform.
Cadwalader, Wickersham & Taft
Associates in the firm’s financial products practice designed and coded a tool called ottoGen, which automatically drafts complex documents needed for certain structured products. The tool halves the time taken to create these documents by drawing on the firm’s existing documents and market data. This has helped lawyers to handle an ever growing workload in this area, as well as offering more predictable pricing to clients. Commended: Jon Mandarakas and Michael Yu.
The litigation team developed a tool, using cloud software Fastcase and Microsoft’s data analytics software PowerBI, that draws on historical case data to assess the risk of evidence spoliation leading to a negative outcome in court. The tool helps lawyers advise clients on the risk in their case, depending on which court they are in. The firm designed a user-friendly interface for the tool to make it easy for clients to understand.
Holland & Knight
The innovation group developed a tool to manage the high level of similar claims requests that the consumer financial and insurance defence practices receive from clients. Built on Amazon Web Services, the tool extracts information from requests and generates the necessary response documents, taking five minutes for a process that would take three hours manually. The firm is looking to apply the software in other practice areas. Commended: Joe Dewey.
The litigation boutique is coding and analysing historic case data to enhance its legal advice to clients. It has applied machine learning to more than 1,600 Supreme Court of Canada leave applications from 2018 to predict the likelihood of a case being heard by the Supreme Court. It has also coded other Canadian courts to perform similar predictive analysis.
FYidoctors, a Canadian eyecare provider, needed to alleviate pressure on its legal department as the company expanded. The firm helped design an automated contract management solution that combines data analytics, cloud storage and e-signature technology. It enables the client to input information and generate contracts at roughly twice the number that would have been created using manual requests. The company also has a fixed fee arrangement for a roster of McCarthy Tétrault’s contract lawyers available on demand.
The firm used to have an email-based process to handle around 1,000 letters received annually from clients requesting disclosures to their auditors about loss contingencies. The firm developed software that automatically triages these requests and assigns them to the appropriate lawyer, sending reminders to respond every 24 hours. Automating the process saves on the costs of handling the requests manually and reduces error and inconsistency in responses.
The firm helped German software company SAP overhaul its compliance programme following allegations of fraud across many jurisdictions. This included implementing risk monitoring tools that use data analytics to detect high risk behaviour and a chatbot to respond to employee questions on compliance. The firm also organised dedicated teams of technologists and compliance experts to monitor the new processes. Business teams were integrated with the overhaul of compliance, to embed the new processes in the business.
The immigration team built a workflow management tool called Caribou to help lawyers and clients manage the immigration processes for foreign workers, storing all the data in one place in a user-friendly format. The software is built on Salesforce and integrated with the firm’s document automation software, and is currently used for more than 20,000 foreign nationals across 70 client companies.