The Phasing Out of LIBOR: Initial Reaction and Preparation
1. Background: Elimination of LIBOR by 2021
As has been widely publicized, on July 27, 2017, the U.K. Financial Conduct Authority announced that LIBOR (London Interbank Offered Rate) the longtime global interest rate benchmark, will be phased out by 2021. LIBOR has been a reference rate used for the past 50 years to determine short-term interest rates, including base-rate derivatives, loans and other short-term instruments.
Both the Loan Syndications and Trading Association (LSTA) and the International Swaps and Derivatives Association (ISDA) have indicated that they will continue to monitor the situation and document reactions to and the evolution of alternative benchmarks.1 We note that many commercial loan agreements already provide for alternative rates in the event LIBOR is not available. Those alternatives typically involve reverting to a different (more expensive) rate or the lender proposing a new benchmark at its discretion.
It is clear that the transition away from LIBOR will be a slow process. The Alternative Reference Rates Committee established by the Federal Reserve Board indicated that the transition would start with derivative transactions, not loan transactions, and would be a “paced transition.” The Federal Reserve Bank of New York indicated on May 24 that the Federal Reserve will seek public comment on the composition and calculation methodology for the benchmark rates before adopting a final publication plan, and that the benchmark rates are not expected to be published until the first half of 2018. Many participants in the derivatives markets will probably wait until they receive guidance from ISDA, and major banks will probably not begin using the new benchmark until they receive guidance from the LSTA.
2. Industry Reponses: Initial Alternatives
The bank loan market has reacted in different ways:
- Bank documents are silent and maintain the existing definition of LIBOR
- Bank documents presently include a change in the definition of LIBOR that allows for the credit agreement to be amended to accommodate an alternative that is “reasonably acceptable” to the borrower and lender
- Bank documents provide that, in connection with any amendment in the definition of LIBOR and/or related provisions in connection with the phase-out of the LIBOR offered rate as a general reference rate for syndicated credit facilities, amendments may be made with the consent of a majority (not 100%) of lenders
The tenor of the facility also appears to affect a bank’s willingness to entertain an alternative.
In the meantime, the ISDA market has been consistent in adopting the status quo option with counterparties opting to wait for ISDA to announce uniform changes.
3. Preparing: Things to Consider Now
It is important to note that this change is coming and to be alert to it when entering into new contracts or modifying existing contractual arrangements. As noted above, we anticipate that the market, lenders and associations will gravitate toward a new standard. As the LSTA has announced, the goal is to have an orderly process over a number of years.
For now, it would be prudent to conduct “due diligence” and assemble loan and swap documentation that uses LIBOR as its reference rate and determine what alternatives (if any) the documents contemplate in the event a LIBOR rate is not available.
Even after a new benchmark is in use, there will be a considerable volume of transactions outstanding that are governed by documents that use LIBOR as the primary benchmark for interest rate calculations. Accordingly, it is not too soon for participants in those transactions to review their documents to be sure they understand what will happen when LIBOR rates are no longer available. Some borrowers may want to amend their credit agreements to change the fallback language.
In new transactions, borrowers will want to pay careful attention to the interest rate benchmark that will be applicable if LIBOR is no longer available.
1 ISDA webinar materials, Development of Fallbacks for LIBOR and other Key IBORs, August 17, 2017; LSTA event materials, LIBOR: Why You Should Care . . . And Shouldn’t Panic, August 17, 2017.