Libor Legal Fix for Phase-Out Hits Hurdle in Congress Tax Spat
(Bloomberg) -- U.S. legislation designed to protect trillions of dollars of assets from chaos when global regulators phase out the interest-rate benchmark Libor is being held up in the House, over a dispute involving tax-related language, according to lawmakers and congressional aides.
Democratic Representative Brad Sherman, who is sponsoring the legislation, said lawmakers are divided about whether to include language aimed at preventing the Internal Revenue Service from recalculating firms’ tax liability at the moment that contracts transition -- a move that could in theory eat into profits for financial institutions.
The Structured Finance Association is lobbying for legislation to prevent $16 trillion of deals -- including mortgages and business loans -- from entering a legal quagmire after pivotal Libor tenors expire in mid-2023. Without a solution, the transition could trigger a barrage of lawsuits over interest payments and “pose a serious risk to the financial system,” the SFA warned senators earlier this month.
Sherman’s bill, H.R. 4616, was approved by the House Financial Services Committee in July but has yet to receive a floor vote despite bipartisan support. The biggest holdup is over a tax provision that says a benchmark replacement shall not “be treated as a sale, exchange, or other disposition of property.”
The House Committee on Ways and Means, which oversees tax policy, is arguing that the language is unnecessary and may overly constrain the IRS’s flexibility to regulate financial instruments.
Representatives for the IRS and the Treasury declined to comment on the matter.
Sherman in an interview said he is open to dropping the language, but expressed doubt about whether the bill would pass soon, because other lawmakers are weighing in.
“You would be surprised when you are dealing with a $20-trillion market how many people come forward with their own ideas,” Sherman said in an interview on Tuesday. “My goal is: make this the biggest problem that you never hear about in my hometown paper.”
The bill is also being delayed due to a smaller issue related to student loans, a congressional aide said. Government subsidies for student loans under the Federal Family Education Loan Program are currently calculated with reference to Libor, and so are affected by the phase-out. Lawmakers are working with the Education Department on the language on such loans and are considering passing that provision separately if the rest of the bill is hung up, the aide said.
Regulators around the world are phasing out the London interbank offered rate, or Libor, which still underpins hundreds of trillions of dollars of assets, following a manipulation scandal and after the trading data underlying the benchmark dried up.
New York passed a law to protect Wall Street in March. But Alabama is the only other state to have passed legislation, and the 48 other states still need protection, said Priya Misra, global head of interest-rate strategy at TD Securities in New York.
Misra, who is a member of the Alternative Reference Rates Committee, the Federal Reserve-backed body guiding the transition, said she didn’t think the IRS should be able to levy more tax.
“We have enough work as it is without worrying about whether it is a taxable event and the implications,” Misra said. “Regulators are forcing the change -- it seems strange to tax people for going through with it.”
The products in question can’t transition to new rates -- partly because they were drawn up before anyone envisioned Libor would end and partly because it’s difficult to persuade borrowers to consent to the switchover. While there is still plenty of time, the legislation that eventually passed in New York took longer than expected.
There have been questions in the past about whether the IRS should be able to tax credit agreements when they exit Libor via contractual fallback language, according to Anne Beaumont, a partner at law firm Friedman Kaplan Seiler & Adelman LLP.
“In the big scheme of things, it’s not a meaningful profit center for the IRS -- it’s more of a technicality,” she said. “If all you’re doing is addressing the lack of fallback language in agreement, I don’t think there’s anyone that thinks that should be a taxable event.”
Financial institutions are urging Congress to resolve any lingering disputes and act sooner rather than later.
“We believe the federal legislation is an urgent priority that will minimize potential financial disruption and facilitate the market’s adjustment to the reference rate transition,” Tom Wipf, chairman of the Alternative Reference Rates Committee and vice chairman of institutional securities at Morgan Stanley, said in a statement. “If passed, the legislation would provide a structural bridge where legacy contracts fail, removing uncertainty and reducing disruption in the markets.”
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