Impending USD LIBOR Discontinuation: Key Considerations for Latin America Loan Market
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This article sets out certain key considerations specific to the Latin American loans market that may arise in transitioning legacy USD LIBOR loans to SOFR and supplements our earlier article published on December 6, 2022 on the impending USD LIBOR discontinuation.
While legal requirements for the transition may vary across the region, below is a brief overview of issues that parties with USD LIBOR exposure may face.
1. Amendment or Replacement of Promissory Notes: International cross-border financings in the region frequently feature a promissory note governed by the laws of the borrower's home country, which qualifies as a titulo ejecutivo or otherwise entitles the lenders to enforce payment against the borrower through summary proceedings.
There is no uniform approach in Latin America to transitioning such promissory notes to SOFR. For example, in some LatAm jurisdictions, promissory notes may already be styled with no reference to a particular interest rate benchmark, thus obviating the need for any action. In other jurisdictions in Latin America, promissory notes or other local law debt instruments will need to be amended or supplemented (such as through an allonge or a reconocimiento de deuda). There may also be some countries where the transition cannot be implemented via an amendment to the promissory note without risking its status as a titulo ejecutivo, and consequently promissory notes may need to be replaced or exchanged.
In all cases, borrowers and lenders should consult with counsel in each applicable jurisdiction and take any appropriate steps in order to avoid adverse legal consequences.
2. Reaffirmations of Collateral: In some jurisdictions in Latin America, an interest rate amendment to a secured loan agreement may be considered a material substantive change to the underlying secured obligation and could potentially be used by third parties to claim that the security interest under a local collateral document became unperfected or at least unperfected to the extent of the difference between the original interest rate (being LIBOR) and the new interest rate (being SOFR plus a credit adjustment spread). Even if lenders get comfortable that, from a commercial standpoint, there is no difference between the two, the unavailability of USD LIBOR after June 30, 2023 may mean that this delta is not capable of being verified, potentially creating some uncertainty in the status of the collateral.
In order to reduce such uncertainty, counsel in some jurisdictions in Latin America recommend, as a matter of best practice, that all grantors party to local security documents execute an acknowledgement or a reaffirmation of the collateral documents and that such acknowledgement or reaffirmation be duly registered with the applicable local registries. While these steps could provide extra comfort to the secured parties, their benefit should be weighed against the burden (including time and cost) of having to prepare additional documents, coordinate with counsel and parties to those documents, comply with the execution formalities and complete the necessary registrations. Secured parties should also consider, in consultation with local counsel, whether the rate switch from USD LIBOR to SOFR will occur on a date certain regardless of whether the local registrations are completed and make sure the documentation allocates responsibility for such registrations and regulates what happens if they are not made.
3. State-owned Entities and Governmental Approvals: In some jurisdictions, a borrower that is a state-owned entity may need to obtain specific approvals from its oversight regulatory agency or ministry to transition legacy USD LIBOR loans to SOFR. Failure to obtain such approvals may result in material adverse consequences for both the borrower and the lenders. In addition, the approval process may be time consuming, so borrowers and lenders should plan ahead and start coordinating with counsel months ahead of the June 30, 2023 discontinuation date for USD LIBOR.
4. Term SOFR Hedging: Parties with USD LIBOR loans may prefer to transition to Term SOFR (as opposed to, for example, daily SOFR) as it most closely resembles USD LIBOR itself. The positive development in many loan markets in recent months has been that many financial institutions are now able to offer Term SOFR derivative products to hedge a borrower's exposure to Term SOFR. However, there continues to be a shortage of liquidity for such instruments across the Americas. As a result, hedge providers may require a higher spread adjustment to compensate for the lack of liquidity as compared to the daily SOFR-based benchmarks. As the hedge market continues to evolve, borrowers and lenders should discuss the state of the market and the need for protection against interest rate variations taking into account the economics of each transaction.
5. Regulatory filings: Some jurisdictions in Latin America (e.g., Brazil and Colombia) require filings in connection with foreign currency debt. In all cases, borrowers and lenders should consult with counsel in each applicable jurisdiction and take any appropriate steps in order to ensure any required updates to such filings in respect of foreign currency loans are made.
The foregoing is only a brief introduction to some issues that frequently arise in connection of the transition to SOFR in the Latin America loan market. It is not intended as an exhaustive list of all issues that may arise in connection with the transition. Parties should review the documentation governing their USD LIBOR exposure and consider the facts of each individual transaction in consultation with counsel.
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