What has been announced?
On 5 March 2021, the Financial Conduct Authority (FCA) announced the dates of cessation or loss of representativeness for all of the LIBOR settings currently published by the ICE Benchmark Administration Limited (IBA). From 31 December 2021, LIBOR will either be discontinued in full or become non-representative for all tenors for GBP, EUR, CHF and JPY, while LIBOR for USD will become non-representative on 30 June 2023, save for 1-week and 2-month USD tenors which will also cease on 31 December 2021. As LIBOR has been the predominant benchmark used in interest-rate setting provisions in global loan markets for years prior to this move by regulators and central banks, there will be a vast number of legacy loan contracts that use LIBOR as its primary benchmark.
Banks and other lending participants in the loan markets have been making great efforts to amend as many of their legacy loan agreements as possible, so that LIBOR is replaced by a risk-free rate (RFR). RFRs used could include SONIA, SOFR or other benchmarks such as base rate, as the Working Group on Sterling Risk-Free Reference Rates has encouraged lenders to progress active conversion of their existing loan book through to completion by 30 September 2021. However, there are protections in place for lenders in the LMA primary documentation to the extent that this exercise has not been completed in relation to any legacy loan contacts.
Replacement of Screen Rate
The transition away from LIBOR has been anticipated ever since the speech by Andrew Bailey of the FCA on 27 July 2017. Since then, the LMA begun hard-wiring mechanisms into its templates for lenders and borrowers to agree replacement benchmarks to the extent that a Screen Rate ceased to be published or to reflect the originally intended economic bargain between the parties. The primary tool for this was the "Replacement of Screen Rate" clause. The precise wording of this clause will depend on which version of the LMA templates was used for the contract in question, since the LMA has been constantly updating its formulation of this clause over the past few years. So:
- for contracts which employ the LMA wording from October 2020 onwards, a "Screen Rate Replacement Event" will have occurred for all LIBOR settings, and this formulation included an obligation on the parties to enter into negotiations to agree any relevant amendments by the backstop date of 31 December 2021, so amendments under this formulation should be completed ahead of the required date for cessation or non-representativeness;
- for contracts using the LMA wording from August 2020 but prior to the October 2020 wording referred to in the paragraph above coming in, a "Screen Rate Replacement Event" will have occurred for LIBOR settings which the FCA announced would cease but not for settings that will become non-representative, as this formulation does not include a "Screen Rate Replacement Event" if the relevant benchmark "to be representative of the underlying market or economic reality", but parties can still agree a Screen Rate Replacement Event has occurred if the Screen Rate for the relevant currency and tenor is "no longer appropriate for the purposes of calculating interest", which came in to the LMA agreements in May 2018;
- for contracts using the LMA wording from May 2018 to August 2020, a Screen Rate Replacement Event will have taken place for LIBOR settings for which the FCA cessation announcement led to a cessation but not for other Screen Rates, but as referred to above parties can still agree that a Screen Rate Replacement Event has occurred for other Screen Rates and settings on the basis that the relevant Screen Rate is "no longer appropriate"; and
- for contracts using the LMA wording from November 2014 to May 2018, a Screen Rate Replacement Event will only occur when a Screen Rate is not available for a currency, i.e. not until cessation.
Lenders and borrowers will therefore need to read which version of the LMA's Replacement of Screen Rate wording was used in the relevant loan documentation, as there will be potentially different implications for each.
If a loan document does not contain a Replacement of Screen Rate clause, or the specific wording used means that a Screen Rate Replacement Event has not yet occurred even when parties would want one to have occurred, the primary option will be to follow the LMA clause around alternative rate-setting mechanisms when a Screen Rate is not available. As there will likely be no available Screen Rate, Interpolated Screen Rate, Reference Bank Rate, Interpolated Historic Screen Rate etc. for a currency or tenor once its setting has either ceased or become no longer representative, parties will likely have to go for the "cost of funds" fallback option due to market disruption. This is often seen as unsatisfactory for borrowers as they have less certainty as to the likely rates of interest they are going to be paying.
Alternatively, it is likely that all lender consent will be required to amend the documentation to introduce the replacement benchmarks that are going to be used, but the market has not yet reached a fully settled position on how compounded reference rates etc. should be calculated, so there may be disagreements in certain lender syndicates around how this should be done.
The transition away from LIBOR now has definitive dates set in stone, and lenders should be getting well prepared for that transition as promptly as they can. However, if there are legacy contracts on lenders' books that have not yet been formally amended, depending on the wording on the contract in question, there may be provisions from which they can take some comfort that they will be able to bring their borrowers back to the negotiating table to re-document the loan contract with a replacement benchmark.
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To find out more about LIBOR, please read our additional resources: