LIBOR: Snapshot of Latest Developments
The current deadline for the cessation of the London Inter-Bank Offered Rate (LIBOR) is the end of 2021. The transition away from LIBOR is, however, a moving target, and its status is constantly changing.
Why Move Away from LIBOR?
LIBOR and other inter-bank offered rates rely on liquidity in the relevant market, where a shortfall in supply causes an inaccurate reﬂection of that rate. Coupled with the 2012 LIBOR-rigging scandal, there has been a very public move from LIBOR towards Risk-Free-Rates (RFRs).
Working groups, think tanks and interested parties have mobilised globally to deal with the transition. In the United Kingdom, the Working Group on Sterling Risk-Free Reference Rates’ frontrunner is the Sterling Overnight Index Average (SONIA), an average of the rates at which banks pay to borrow sterling from other ﬁnancial institutions overnight.
The United States favours the Secured Overnight Financing Rate (SOFR), while the Eurozone champions the Euro Short-Term Rate (€STER). These rates are currently in use for various purposes, e.g., SONIA is used by ﬁnancial institutions to calculate the interest paid on swap transactions.
There are, however, question marks over whether RFRs are developed enough to use in most loan documentation. Each variation of RFR has its shortfalls, principally that LIBOR is forward-looking from the beginning of an interest period, while RFRs are backward looking, making it difficult for borrowers to forecast and set future budgets, potentially making hedging more expensive.
One solution offered to solve this problem is a "look-back" period. This uses an observation period starting and ending a certain number of days before the interest period to calculate the rate of interest, giving the parties advance notice of the amount of interest due.
The Financial Stability Board has recently published a roadmap, which details the steps parties should be taking. The expectation is that, by the end of 2020, lenders should be in a position to offer non-LIBOR linked loans.
Parties need documentation to be future-proofed to cater for this transition. Loan agreements will need to be amended, with parties needing to consider whether to either include documentary amendment mechanics to allow for subsequent changes to the interest provisions in the future, or hardwire an alternative rate, with due regard to potential tax and/or accounting issues.
Latest Transatlantic Developments
In the United States,
The Alternative Reference Rates Committee has released recommended fall-back language for loan agreements.
The Loan Syndications and Trading Association has released draft language referencing SOFR in an effort to educate market participants on the replacement benchmark.
The Intercontinental Exchange (ICE) recently announced plans to cease 1 week/2 month US$ LIBOR on 31 December 2021, with the remaining terms to cease on 30 June 2023, giving an additional 18 months of time for the development of a potential forward-looking version of SOFR.
In the United Kingdom, the Loan Market Association has released
A recommended form of replacement screen rate provisions, allowing the borrower and agent (on behalf of the requisite lenders) to agree amendments to the use of a replacement benchmark on the occurrence of a screen rate replacement event.
A SONIA-based sterling term and revolving facilities agreement.
GlaxoSmithKline plc has signed new SOFR and SONIA-linked revolving credit lines, marking the ﬁrst large-scale multicurrency loan agreement to be executed directly referencing RFRs.
Whilst the current deadline for the cessation of LIBOR is the end of 2021, it is likely that the recent ICE announcement concerning US$ LIBOR will put pressure on administrators to consider extending the deadline for LIBOR quoted in other currencies.