Important Information Regarding LIBOR- and SOFR-linked Products

The following Frequently Asked Questions (FAQs) are relevant to holders of securities and instruments directly or indirectly linked to the London Interbank Offered Rate (LIBOR) or the Secured Overnight Financing Rate (SOFR), as well as investors who are considering purchasing these products. Depending on your current holdings and investment plans, this information may or may not be applicable to you.

LIBOR has been the subject of regulatory scrutiny due to concerns with the structural integrity of this interest rate benchmark and how it is determined. In response to these concerns, central banks around the world have established committees, like the Alternative Reference Rates Committee (ARRC) in the United States, with the goal of finding alternative rates for their currency's LIBOR.

In particular, all settings for USD, GBP, EUR, JPY and CHF LIBOR are no longer being published on a representative basis as of June 30, 2023; synthetic versions of certain USD and GBP LIBOR settings will be published for a period of time for the purpose of managing existing LIBOR-based products.

The following FAQs are not intended to be a comprehensive summary of the replacement of USD LIBOR and other currency LIBORs, or of SOFR. These FAQs are intended as a summary of recent developments and considerations relevant to Morgan Stanley clients. This is a developing situation, and the below information is subject to change.

What is LIBOR and Why Was It Discontinued?

LIBOR was an interest-rate benchmark that was widely used in bond, loan, and derivative contracts, as well as in consumer lending instruments such as mortgages. LIBOR was intended to represent the rate at which certain large banks obtain wholesale, unsecured funding from one another. However, concerns with the integrity of LIBOR led to its cessation.

What is SOFR?

The ARRC selected SOFR as its recommended alternative to USD LIBOR. Certain other USD LIBOR alternatives exist in the market but have not been recommended by the ARRC.

SOFR is an interest-rate benchmark that is a broad measure of the cost of borrowing cash overnight when collateralized by U.S. Treasury securities. The Federal Reserve Bank of New York began publishing SOFR in April 2018.

SOFR is not the economic equivalent of LIBOR. SOFR is a secured rate, while LIBOR is an unsecured rate. As a result, SOFR-based products may not perform in the same way as LIBOR-based products would have.

How Does the Cessation of LIBOR Affect LIBOR-linked products?

"Fallback" provisions in bond, loan, derivative or consumer lending documentation may apply. "Fallback" provisions are contract terms that provide for how the applicable interest rate will be calculated if the reference interest rate (LIBOR, for example) is temporarily or permanently unavailable at the time of a required interest or dividend payment determination. The documentation for LIBOR-linked products may contain these provisions, which can materially differ across products and even within a given asset class.

Furthermore, depending on how a fallback provision is written, it may not be favorable to investors.

Fallback provisions may not contemplate alternative reference rates like SOFR, particularly in older documentation, and/or may result in increased uncertainty and change the economics of the product upon LIBOR cessation. For example, a fallback provision may provide that the interest rate for a security will revert to the LIBOR rate of the prior interest period. This would have the effect of converting the security from a floating to a fixed rate security upon LIBOR cessation. While it is more likely that new issue LIBOR-linked products contained fallback provisions that contemplated the cessation of LIBOR, this may not always be the case. In addition, there may be a population of LIBOR-based products that cannot be amended due to an inability to obtain sufficient investor consent, such as bonds with high noteholder consent requirements, and even if consent is obtained, your interests may not be aligned with those of other holders. Clients utilizing hedging strategies may also face basis risk due to inconsistent fallback provisions in their various investments.

U.S. federal legislation was signed into law that addresses certain contracts that mature after LIBOR ceased to be published on a representative basis and have no effective means to replace LIBOR. Specifically, the legislation overrides these contracts with a SOFR-based rate plus a spread and allows an "opt-in" to this solution where one of the contract parties has discretion in selecting an alternative rate to LIBOR. However, the legislation will not override contracts that are not governed by U.S. law, that automatically fall back to non-LIBOR rates (e.g., Prime) or fixed-to-floating rate securities that will fall back to a specific fixed rate when LIBOR is not available during the floating rate period. As a result, the products governed by these contracts may not have an effective means to replace LIBOR or may not have the outcome investors were expecting.

How Does the Cessation of LIBOR Affect My Investments?

Clients who currently hold LIBOR-linked products and/or are considering purchasing LIBOR-linked products should be aware that the market transition away from LIBOR to alternative rates is complex and could have a range of impacts on financial products and transactions directly or indirectly linked to LIBOR. LIBOR-linked securities that do not have an adequate way to address the cessation of LIBOR, or that will remain fixed-for-life, and any uncertainty related to the determination of the rate, may negatively impact the pricing, liquidity, value of, return on and trading of these securities.

Further, we cannot predict whether or the extent to which the emergence of SOFR-linked products will adversely affect the prices and liquidity of LIBOR-linked products.

As a result, you should understand the transition away from LIBOR and the developing market in SOFR-linked products if you currently hold LIBOR-linked products or are interested in purchasing LIBOR- or SOFR-linked products. Given the transition away from LIBOR, you should be aware of the maturity dates of your LIBOR-linked products and, for fixed-to-floating rate products, the conversion date.

How is SOFR used to calculate interest?

At present, the SOFR-linked products that have been issued apply different market conventions to calculate interest. For example, SOFR-linked products can calculate interest using either a simple or a compounded average of daily SOFR rates. Some products may refer to an average of SOFR rates observed before an interest payment begins, while others may reference an average of SOFR over the current interest payment period (in which case the interest paid on your investment will not be known until the end of that period).

The ARRC also supports a forward-looking term SOFR rate as the replacement fallback rate in certain products. Due to the differences in determining the applicable interest rate, you should understand that the interest rate for any particular SOFR-linked product may not be the same as the interest rate on other SOFR-linked products. Please refer to the product offering documents for a description of the specific formula used to calculate the interest rate.

What Are My Next Steps?

As with any investment, make sure you understand the terms of your LIBOR- or SOFR-linked products and the terms of those that you are considering purchasing. It is important to understand how your holdings will be impacted by the LIBOR cessation.

Please contact Customer Service if you would like additional information on LIBOR-linked products. You should also consult with your tax and/or legal advisors for information concerning your individual situation as Morgan Stanley does not provide tax or legal advice.

Other Important Information

Morgan Stanley participates on central bank committees, including the ARRC, that are selecting LIBOR alternative rates, developing transition plans for trading these new rates and preparing for the cessation of LIBOR. Morgan Stanley and its affiliates may have interests with respect to LIBOR- and SOFR-linked products that conflict with yours as an investor.

Information contained herein has been obtained from sources considered to be reliable. Morgan Stanley Smith Barney LLC does not guarantee their accuracy or completeness.