Introduction
In October 2017 we looked at the prospect of LIBOR, EURIBOR and other inter-bank offered rates (together IBORs) being replaced by alternative near risk free rates (RFRs). Read our 2017 article here.
Whilst these rates are still being developed, it seems likely that LIBOR and other IBORs will fall out of use by the end of 2021. That is only just over 2 ½ years away. There are complex practical issues which lenders will have to grapple with and, tied in with these, it is clear that lenders should be future-proofing not only their new facility documentation but also their existing facility documentation where the facility period extends beyond 2021.
It is beyond the scope of this note to explore the challenges in settling on term-based RFRs under various currencies, but it looks likely that, in order to arrive at term-based RFRs, it will be necessary to use data from futures markets for overnight interest rates (such as SONIA (for Sterling), €STR (for Euros) and SOFR (for USD). The problem is that such futures markets are currently very limited or non-existent. It goes without saying that, until such RFRs are settled, it is not possible to prepare interest rate provisions which regulate their use. On the other hand, the alternative interest rate provisions currently used in most facility agreements are intended to provide a short term fix rather than to provide a long term solution for a permanent discontinuance of the relevant benchmark rate. The challenge, therefore, is to come up with wording for facility agreements which provides a framework for amending them as and when the new RFRs come in to use.
What to do about New Facility Agreements?
It is instructive to see what the Loan Market Association are doing. Their current "replacement of screen rate" clause was published on 25 May 2018 (and updated on 16 October 2018). If you are not a member of the LMA, you can find this clause on the Bank of England website as a pdf called Syndicated Loan Replacement of Screen Rate clause. The clause simply provides the mechanism for replacing the Screen Rate with a new benchmark rate and the amendment of related provisions.
This includes, importantly, a provision for “adjusting the pricing to reduce or eliminate, to the extent reasonably practicable, any transfer of economic value from one Party to another”, in other words, to prevent either the lenders or the customers losing out financially. It also provides that the amendments “may be made with the consent of the Agent (acting on the instructions of the [Majority Lenders]) and the Parent”. Note that “Majority Lenders” is square-bracketed – given the pricing implications, some syndicate members may look for a higher consent threshold. Note also the reference to “Parent” – this is not something which can be imposed on customers unilaterally.
There is also optional wording within the clause which would make it only applicable if a specific trigger event occurs – see definition of “Screen Rate Replacement Event” in the clause. Given that, as noted above, the clause requires a level of lender consent (majority or higher) and customer consent, the inclusion of such a trigger event serves to protect minority lenders who may be more financially affected by such a change. Such a trigger event is not, therefore, going to be appropriate in all syndicated loans.
The LMA clause, of course, is designed for syndicated loans, but some of the principles can be adopted for single bank loans as well, to create a simple mechanism for negotiating amendments to incorporate a new benchmark with an appropriate spread adjustment to make the change economically neutral.
The LMA clause is an example of the “amendment approach” but another approach, the “hardwired approach”, is being explored, particularly by the ARRC (Alternative Reference Rates Committee, who are working on alternatives to USD LIBOR). A hardwired approach seeks to offer a clear waterfall for selecting a replacement benchmark and spread adjustment that would apply if LIBOR is no longer usable. So, for example, if a trigger event occurs, the first fallback rate could be a forward-looking term SOFR but, if that rate does not exist, compounded SOFR should be used if it exists and so on. The ARRC is currently consulting on the proposed language for a hardwired approach which includes a four-step replacement benchmark waterfall, specifying the priority of particular successor rates to be used. It is therefore a “work in progress” and we will report again when things become clearer.
What to do about Existing Facility Agreements?
Finally, a word on existing facility agreements. Lenders should consider reviewing these to check:
- Are there adequate fallback provisions that would apply if the relevant IBOR ceases to be produced, or if a replacement rate begins to be used in the loan markets, and could these be used on a long-term basis? As noted above, this is unlikely as most fallback provisions are designed for short term market disruption.
- What is the procedure for amending the facility agreements to change the interest provisions? When do the provisions apply (trigger event)? What level of lender involvement is required (for example, unanimous consent or majority lender consent)? How do the provisions work e.g. who selects the replacement rate, how is the new rate selected, do the provisions cover all necessary changes including margin adjustment to achieve economic equivalence?
- Consider also whether there are any restrictions contained in intercreditor arrangements, for example, is the consent of another group of creditors in the capital structure required to any amendments relating to the interest provisions?
- Any hedging arrangements also need to be considered to ensure consistency as far as possible.
We suspect that, in many cases, there will not be adequate fallback provisions that address all these issues. Lenders should then consider discussing with their customers appropriate amendments to future-proof their facility agreements along the lines discussed above.
We are here to help
This is a complex area. Our banking team has the specialist knowledge and experience to help you with this. Whether you are external lawyers or in-house lawyers, we can assist you to conduct reviews of existing facility agreements or to develop appropriate wording for new facility agreements. As always, our rates are substantially lower than the London-based firms. Please contact: