Following the ARRC-recommended deadline for shifting to hardwired fallbacks, the syndicated loan market has begun to show signs of change
Based on best practices published by the Alternative Reference Rates Committee (ARRC), the "amendment-approach" fallback provisions for LIBOR replacement were recommended to be discontinued by the end of Q3 2020 in favor of the more robust "hardwired approach." According to a recent market analysis by Covenant Review, hardwired fallbacks have now begun to emerge in the syndicated loan market; however, the amendment approach continues to be used widely.
In an analysis of 120 syndicated loans that were issued or amended in the October-December 2020 period, Covenant Review found that about 42% still contained the ARRC’s amendment-approach language while about 24% chose the hardwired approach. Focusing on December 2020 alone reveals that the use of the amendment approach and the hardwired approach ended the year in a dead heat, with each fallback appearing in about 34% of deals analyzed from that month.
While hardwired language has become increasingly common, the data shows that a number of market participants continue to use the amendment approach notwithstanding the ARRC’s recommendation to the contrary. In some cases, market participants have cited a desire to "retain flexibility" as a rationale for using the amendment approach. Others have pointed to potential issues with the ARRC hardwired language, such as the lack of a "flip-forward" to term SOFR1 and the fact that market conventions for the administration of SOFR loans have not yet been developed.
It ultimately remains to be seen whether hardwired language will become the dominant fallback as new issuances come to market in the early months of 2021. The ICE Benchmark Administration (IBA) is expected to soon announce definitive end dates for publication of the various USD LIBOR tenors, and this development could spur increased hardwired adoption.
Meanwhile, focus is already shifting to the next phase of the transition. Late last year, US regulators issued a statement outlining their belief that "entering into new contracts that use USD LIBOR as a reference rate after December 31, 2021, would create safety and soundness risks," and that the regulators "will examine bank practices accordingly." The ARRC's best practices provide a buffer period by recommending that all new syndicated loan issuances use a non-LIBOR benchmark after June 30, 2021. And the chair of the ARRC, Tom Wipf, has expressed even greater urgency, writing in a recent article for Bloomberg that "market participants should immediately stop issuing USD Libor-based instruments and start writing SOFR into new contracts."
For additional information and resources on the IBOR discontinuation and transition, you can visit White & Case's LIBOR Hub.
1 The ARRC's hardwired language provides a waterfall of potential replacement rates. The actual replacement rate that will be utilized depends on what is available at the time replacement is required to occur. Term SOFR is the first option in the waterfall, but does not yet exist. If replacement must occur prior to the development of term SOFR, then the second option in the waterfall—simple SOFR in arrears—would be used. As published by the ARRC, the hardwired language does not include a mechanism to subsequently “flip-forward” to term SOFR if it becomes available later on. Some market participants have added such a mechanism.
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