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Is the end of LIBOR now in sight for the loan market?

On 5 March 2021, the Financial Conduct Authority ("FCA") announced (the "FCA Announcement") the future cessation or loss of representativeness for all 35 LIBOR settings currently published by ICE Benchmark Administration Limited ("IBA"). This note sets out key aspects of the FCA Announcement and considers its potential impact on English law LMA loan documentation.

 

FCA Announcement: cessation or non-representativeness?

The FCA Announcement confirmed (i) the permanent cessation of at least 29 LIBOR settings immediately after 31 December 2021, 30 December 20221 or 30 June 2023 (as applicable); and (ii) that 9 additional LIBOR benchmark settings will no longer be "representative of the underlying market and economic reality […], that such representativeness will not be restored […] with awareness that the announcement or publication will engage certain triggers" immediately after the dates noted below. The FCA further noted its intention to consult on use of its proposed new powers to require IBA to publish certain LIBOR settings on a synthetic basis following 31 December 2021 with the intention of protecting market integrity by reducing disruption and to continue to consider the case for use of those powers in the context of USD LIBOR settings after 30 June 2023. We expect the use of synthetic rates going forward to be limited2 (for example, in circumstances in which market participants are unable to amend "tough legacy" contracts) and the general expectation is that the market will transition on or before the relevant dates set out below.

Following the FCA Announcement, IBA, the administrator of LIBOR, announced (the "IBA Announcement") that it would be unable to publish on a representative basis (i) all GBP, EUR, CHF and JPY LIBOR settings and 1-week and 2-month USD LIBOR settings immediately following 31 December 2021; and (ii) Overnight and 1-month, 3-month, 6-month and 12-month USD LIBOR settings immediately following 30 June 2023, and that it would have to cease publishing such settings unless the FCA exercises its proposed powers to require IBA to publish those settings on a synthetic basis.

On 5 March 2021 (as updated on 8 March 2021), the International Swaps and Derivatives Association, Inc. ("ISDA") confirmed that the FCA Announcement constitutes an index cessation event under the ISDA IBOR Fallbacks Supplement and the ISDA 2020 IBOR Fallbacks Protocol for all 35 LIBOR settings and as a result the fallback spread adjustment published by Bloomberg is fixed as of the date of the announcement for all LIBOR settings.

On 8 March 2021, the Alternative Reference Rates Committee ("ARRC") issued a statement confirming that in its opinion, the IBA Announcement and the FCA Announcement on future cessation and loss of representativeness of the LIBOR benchmarks constitutes a "Benchmark Transition Event" with respect to all USD LIBOR settings pursuant to the ARRC recommendations regarding more robust fallback language for new issuances or originations of LIBOR floating rate notes, securitisations, syndicated business loans and bilateral business loans.4

 

Impact on Existing Loan Documentation

Rate Switch Provisions

In documentation that includes rate switch mechanics on the terms of the LMA's November 2020 or January 2021 Exposure Drafts, a "Rate Switch Trigger Event" will have occurred on 5 March 2021 in respect of all EUR, CHF, JPY, GBP and USD LIBOR settings on the basis that:

  • Permanent cessation announcement: Paragraph (a)(iii) of the "Rate Switch Trigger Event" definition applies where5 "the supervisor of the administrator of that Screen Rate publicly announces that such Screen Rate has been or will be permanently or indefinitely discontinued…for any Quoted Tenor". The FCA Announcement in respect of the future cessation of certain LIBOR settings in a currency therefore constitutes a Rate Switch Trigger Event for all settings in that currency.
  • Non-representativeness announcement: Paragraph (b) of the "Rate Switch Trigger Event" contemplates a trigger where the "Screen Rate for any Quoted Tenor is no longer, or as of a specified future date will no longer be, representative of the underlying market and the economic reality that it is intended to measure and that such representativeness will not be restored (as determined by such supervisor)…with awareness that the announcement or publication will engage certain triggers". The FCA Announcement in respect of the future non-representativeness of certain LIBOR settings in a currency therefore constitutes a Rate Switch Trigger Event in respect of all settings in that currency.

While a Rate Switch Trigger Event has occurred for all 35 LIBOR settings, any actual rate switch would only occur on a per currency basis (for all tenors in that currency) by reference to the Rate Switch Date for a currency. The Rate Switch Date is the earlier of: the agreed "Backstop Rate Switch Date"; and the "Rate Switch Trigger Event Date", for that currency.

The LMA rate switch provisions (as emphasised by the LMA's commentary on the exposure drafts) are intended to operate so that a Rate Switch Trigger Event Date occurs for a currency on the first date on which any LIBOR setting in that currency ceases to be published or is no longer representative.6 The Rate Switch Trigger Event Date for all of EUR, CHF, JPY, GBP and USD is therefore due to be 1 January 2022. Under LMA rate switch provisions in an agreement under which only some or all of 1, 3 and 6 USD LIBOR were applicable as potential interest periods, USD would therefore nonetheless transition on 1 January 2022, since on that date there would be a "Rate Switch Trigger Event Date" for 1 week and 2 month USD LIBOR settings. Where a loan contains an earlier Backstop Rate Switch Date, the rate switch provisions will apply from that earlier date.

We note that this position differs from the ISDA and ARRC positions on benchmark transition. Pursuant to the ARRC7 recommended fallback methodology, the transition to the use of compounded risk-free reference rate will only occur when all "Available Tenors" (applicable to Interest Periods available for selection under the loan) of the benchmark cease to be provided or are no longer representative. Under the ISDA IBOR Fallbacks Supplement, there is no "Index Cessation Effective Date" for as long as it is possible to determine an interpolated rate under the "Discontinued Rates Maturities" provisions.

Agent banks should note that the occurrence of a Rate Switch Trigger Event triggers a notification obligation.8 Agents are required to notify Lenders and the relevant Company promptly upon becoming aware of: the occurrence of a Rate Switch Trigger Event; the Rate Switch Trigger Event Date applicable to that trigger event; and the occurrence of the Rate Switch Date for a currency.

Replacement of Screen Rate Provisions9

The position under legacy LMA facility agreements will vary depending on the version of (and the details of the actual terms as implemented into loan documentation based on) the LMA's "Replacement of Screen Rate" provisions (if) included.

The LMA's Replacement of Screen Rate provisions have the effect of lowering the consent threshold to (typically) Majority Lender consent (as opposed to all Lender consent) in respect of amendments to the loan agreements dealing with the replacement of benchmark rates.10 In contrast to LMA rate switch provisions (which, as noted, give a rate switch trigger on a per currency basis for all tenors of the rate switch currency off the first benchmark trigger event date for a setting in that currency (whether or not applicable to loan interest periods under the document)), the replacement of screen rate provisions operate on a per tenor basis for the screen rate for a currency capable of being selected for a loan.

  • LMA wording from October 202011 – Under this formula, a "Screen Rate Replacement Event" will have occurred for all LIBOR settings on the basis of a combination of the cessation and (for the tenors for which there is not a cessation announcement) non-representativeness components of the FCA Announcement. LMA agreements with this specimen wording would have included "amendment" wording as per August 2020 wording below. On the basis that the backstop date for conversion to use of the replacement benchmark should have been set prior to 31 December 2021, parties should in any event have completed amendments for use of replacement benchmark terms ahead of the relevant dates for cessation or non-representativeness.
  • LMA wording from August 2020 but not October 2020 – Under this formula, a "Screen Rate Replacement Event" will have occurred for LIBOR settings for which the FCA Announcement contained a cessation announcement but not for other Screen Rates, since the wording does not provide for a Screen Rate Replacement Event where the relevant setting ceases "to be representative of the underlying market or economic reality". LMA agreements with this specimen wording would have included wording as per December 2018 below to enable the application of a "Screen Rate Replacement Event" to a Screen Rate by Majority Lender and Obligor agreement on the basis of that setting being "no longer appropriate". LMA August 202012 wording uses a pre-specified date to require parties to enter into negotiations in good faith on use of a replacement benchmark with an agreed backstop date (to be set in advance of 31 December 2021) for conversion to use of the replacement benchmark.
  • LMA wording from May 201813 but not August 2020 – Under this formula, a "Screen Rate Replacement Event" will have occurred for LIBOR settings for which the FCA Announcement contained a cessation announcement (since it provides for a trigger where a supervisor publicly announces future permanent discontinuation) but not for other Screen Rates. However, Parties may agree (provided that Majority Lender and Obligor consent is obtained) to apply a "Screen Rate Replacement Event" to any other setting on the basis that the Screen Rate for that currency and tenor is "no longer appropriate for the purposes of calculating interest"14 under the agreement.
  • LMA wording from November 2014 to May 2018 – Under earlier versions of the Replacement of Screen Rate provisions, a "Screen Rate Replacement Event" for a setting is only triggered where that Screen Rate is not available for a currency. On that basis, a trigger event under the clause will not occur until actual cessation, i.e. immediately after 31 December 2021, 30 December 2022 or 30 June 2023 (as applicable) for the setting for which a cessation announcement has been made.

Loan documentation without Replacement of Screen Rate provisions

To the extent that LMA Replacement of Screen Rate provisions have not been included in loan documentation (or do not apply):

  • all Lender consent may be required for the purposes of amending the documentation to convert to the use of replacement benchmarks; and
  • the per Interest Period fallbacks in loan documentation will apply to the calculation of the relevant benchmark rate component of interest where "no Screen Rate is available" for the relevant benchmark rate.

 

Transition timetable

Regulators, RFR working groups and industry bodies have again reminded market participants of the need to complete their transition plans. With the recommendation of The Working Group on Sterling Risk-Free Reference Rates that, from the end of March 2021 sterling LIBOR is no longer used in any new lending or other cash products that mature after the end of 2021 and existing US supervisory guidance that banks transition away from USD LIBOR as soon as practicable,15 the FCA Announcement gives yet greater focus and impetus to the transition.

 

1 The 1-month, 3-month and 6-month JPY settings "overlap" in that both paragraph 5 (cessation) and paragraph 8 (non-representativeness) of the FCA Announcement refer to them.
2 The FCA will have powers under the proposed Financial Services Bill (if enacted) to: prohibit new use by UK regulated firms in regulated financial instruments of synthetic LIBOR settings; exempt from this prohibition the continued use of these settings under legacy contracts; and to require changes to the benchmark's methodology. The FCA made separate statements of policy on 5 March 2021 with respect to its exercise of these proposed powers.
3 Please see footnote 1 above. 
4 See our separate briefing for the US markets.
5 Emphasis added.
6 See paragraphs (b) and (c) of the definition.
7 See our separate briefing for the US markets.
8 Clause 9A.4 of the November 2020 or January 2021 exposure drafts.
9 The analysis set out here is based on the specimen LMA wording and will not be applicable to the extent that parties have documented an alternative position.
10 The analysis below assumes that parties included the optional wording making the operation of the clause contingent upon the occurrence of a "Screen Rate Replacement Event". If this optional wording has not been included, then the clause would apply to amendments to documentation irrespective of the occurrence (or not) of a Screen Rate Replacement Event.
11 The dates for "LMA wording" reference the publication dates of the LMA's Replacement of Screen Rate clause provisions as revised from time to time.
12 This was designed to facilitate satisfaction with The Working Group on Sterling Risk-Free Reference Rates' recommendation that, after Q3 2020, lenders include "contractual arrangements to facilitate conversion ahead of end-2021" in all new and re-financed LIBOR-referencing loan products.
13 While the LMA made updates to the Replacement of Screen Rate guidance in October and December 2018, there were no substantive changes to the wording of the clause.
14 Paragraph (d) of the definition of Screen Rate Replacement Event.
15 The US agency statement of 30 November 2020 on LIBOR Transition encourages banks "to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021. New contracts entered into before December 31, 2021 should either utilize a reference rate other than LIBOR or have robust fallback language that includes a clearly defined alternative reference rate after LIBOR's discontinuation".

 

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