The Phaseout of LIBOR: Contracting for the Unknown

The Financial Conduct Authority (FCA) announced in July 2017 that by the end of 2021, it would stop compelling banks to contribute LIBOR quotes. This announcement, considered by many as the death sentence for LIBOR, has triggered efforts to move toward new benchmark rates. However, despite the emergence of some frontrunners to act as a replacement rate (most notably SONIA and SOFR) from working groups from across the LIBOR jurisdictions, there remains no absolute market consensus on LIBOR’s successor. This uncertainty means that participants to the debt markets should think carefully about the benchmark provisions in their loan documentation and consider the merits of adopting the new optional wording published by the Loan Market Association (LMA).

LIBOR, the internationally recognised benchmark figure used by an estimated $350 trillion worth of securities, swaps, and other finance contracts, looks set to be phased out by the end of 2021. Loan parties to new or existing contracts that reference LIBOR and have terms running into 2022 should consider drafting, or making amendments to include, appropriate provisions that accommodate this.

However, with the identity of LIBOR’s successor still uncertain, loan parties should exercise caution before nominating a different benchmark (a decision that may not be followed by the market). Until a LIBOR replacement is identified, parties should look to ensure that their contracts contain workable fallback provisions that afford them sufficient flexibility to amend their benchmark provisions in the future.

To assist loan parties with this, the LMA in October 2018 published updated optional wording that can be added to loan documents. This wording affords loan parties the flexibility to amend the benchmark provisions in their documents to account for LIBOR’s replacement, as and when one emerges[1].

Though LMA’s optional wording is a useful resource, loan parties should consider a number of different issues when deciding whether to rely upon it.

The Current Default Position

The benchmark provisions in LMA standard form English law loan documentation already provide contingencies in the event of LIBOR’s unavailability or illiquidity.

However, such fallback provisions, and the benchmark rates they contain, are intended only for temporary use and should not be considered a suitable permanent solution.

The LMA’s Optional Wording

To assist loan parties with preparing for the shift away from LIBOR, the LMA in October 2018 updated optional wording—first published in November 2014—which can be added to standard form LMA loan documentation.

Named the “Revised Replacement of Screen Rate Clause”, this provision allows the loan parties to make amendments that will facilitate the inclusion of a replacement benchmark rate upon the occurrence of a trigger event – a “Screen Rate Replacement Event” (SRR Event). Such a replacement benchmark rate will be one which

• is formally selected as a replacement for LIBOR by the LIBOR administrator or by an appropriate regulator; or
• is otherwise accepted by the relevant markets; or
• is deemed appropriate by a majority of lenders (or another group of loan parties, as specified by the loan parties).

The advantage of including this provision is that it allows loan parties to make changes to a contract’s benchmark rate using a lower lender consent threshold than would otherwise be required. This wording has been endorsed by the Working Group on Sterling Risk-Free Reference Rates, the UK working group tasked with identifying a LIBOR replacement.

Analysis of the LMA’s Optional Wording

There are several considerations that loan parties, particularly borrowers, should take into account before inclusion of the LMA recommended wording:

• Whether they are comfortable with each of the SRR Events
• Whether it is appropriate for the provisions of the New Clause to operate only upon the occurrence of an SRR Event
• Whether a simple majority of lenders is the appropriate consent level in the context of the lending group
• What additional interest adjustment (eg., to the margin) might be needed where the eventual replacement benchmark rate is different from LIBOR
• Who should be responsible for the costs and expenses relating to any amendment or waiver contemplated

Loan parties should also have regard to some of the problematic elements of the recommended LMA wording, which may cause a number of issues, including:

• Where the SSR Event is the decision of a certain group of loan parties, an increase in lender-lender disputes in circumstances where minority lenders object to the decision of the majority
• Where the SSR Event is the decision of a certain group of loan parties, stalemates caused by lender-borrower disputes where the parties fail to agree on a replacement. In such circumstances, changes are required to the “costs of funds” provisions in the loan documents (being the ultimate fallback position where a consensus is not reached)
• The provisions do not deal with bilateral loans
• The loan documentation is likely to need considerably more amendments than the mere substitution of a benchmark rate
• The provisions do not deal with multi-currency loans, a particular problem if different LIBOR jurisdictions adopt replacement benchmark rates with diverging characteristics and at different times

Alternative Proposals for Wording

There are a number of alternatives or potential amendments to the LMA’s optional wording that loan parties may wish to consider. For example, one option might be to vest in the agent the discretion to elect a replacement benchmark rate in certain scenarios.

Alternatively, loan parties could consider the use of “negative consent” provisions, whereby upon the occurrence of an SSR Event, the borrower and agent can agree on a replacement benchmark rate, subject to a negative consent right of the majority lenders.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

London
Bruce Johnston
Paul Denham
Nichola Foley

[1] The Alternative Reference Rates Committee in the USA has published different wording that is being increasingly used in US style loan documentation.