It is the best part of a year since Andrew Bailey's speech set the financial markets on an apparent course to a brave new LIBOR-less world. It then took a few months before the industry (including the regulators) got together and put in place working groups and action plans to address the likely discontinuance of LIBOR. While it is an appreciably mammoth task to pivot the world of finance away from LIBOR and towards more appropriate risk free rates (RFRs), it's fair to say that the regulators (if not the markets as a whole) generally have the turning circle of the Titanic.
These days, however, many clients don't. They are agile and dynamic. They will spot obstacles on the horizon (I'll leave the Titanic metaphor there I think) and expect their in-house teams and external advisors to have done the same, and proactively work on ways to overcome or manoeuvre around them.
So far the FCA has stressed the need for "active planning" for a move away from LIBOR, and raising public awareness about the need for transition. The Bank of England and the Fed yesterday urged markets to get on with it. But while law firms and trade associations have been busy pushing out alerters over the past 11 months about the potential impact of LIBOR discontinuance and the ramifications for existing and new transactions, there is so far little evidence that market participants (in the UK loan markets at least) are actively seeking to amend their legacy contracts or incorporate wording that future-proofs new loans maturing (or with payment obligations after) the 2021 'deadline'.
This is a result of two related issues:
- The absence of a drag-and-drop replacement for LIBOR. Current RFRs remain a different beast to IBORs and the reform process is ongoing.
- The anticipation of the Loan Market Association's provision of slot-in clauses, and the understandable reluctance of law firms to draft (or advise their clients to actively confront these issues) when so much about the post-LIBOR landscape is unknown.
However the LMA has today published the wording (effectively a revised replacement of screen rate rider) and the noises are that the RFR working groups are making solid progress, so what's the rush?
One view is that only the larger borrowers are engaging on the issue at the moment, talking to their lenders. In the absence of anything to put to the markets (that is, in terms of an appropriate replacement product), it might be that there isn't much that can be said or done, until such time as an appropriate product is on the table.
The four year timescale set by the FCA was intended to allow time for existing arrangements to roll off or be refinanced, at which time transitions could be managed. There's a sense it's tomorrow's problem. Well perhaps wait and see, or that tiresome trope "Keep calm and carry on", isn't an appropriate strategy in all circumstances. Clearly there are many, many loans out there that are only loosely based or not based at all on LMA terms. Moreover there are likely to be countless other commercial contracts that have used LIBOR as a basis for interest calculations (rightly or wrongly) and certainly won't include anything like the vaunted (but flawed) benchmark rate fallback provisions that have provided comfort to the industry in the short term. The LMA drafting in those circumstances probably won't achieve much. A longer term concern is that while 2021 is when the FCA will no longer require banks to submit LIBOR rates (and it may not disappear from screens overnight), it's possible that LIBOR will lose the confidence of the market or be seen as an appropriate rate sometime before that.
And there are things that can be done now. For a start, we can look to identify affected contracts across the full range of borrowers and lenders where LIBOR may be used as a basis. Diligence should identify matters such as:
- What calculation mechanics are used? (That is, what are the components of any interest provision and how are the relevant numbers arrived at.)
- What rate fall back provisions are used (including identifying trigger events)?
- What amendment provisions are there?
Once we have identified the legacy contracts we can begin thinking about amendments. The same issues will broadly also apply for new deals, that is:
- What are the appropriate trigger points for rate replacements? (We don't have to pick an RFR, some other rate or calculation methodology now, just provide a means of starting dialogue or consultation on an acceptable alternative.)
- What are the mechanisms in documents that need to be changed? (Anticipating a need to change documents beyond the simple rate calculation mechanics.)
- How do the parties expect to agree any changes? (Deciding who has a say in agreeing changes, in terms of voting rights/consents and how to resolve any impasse.)
Of course in many instances clients will prefer to respond in step with the industry – and the LMA wording provides a helpful starting point - but we must be alive to those cases that don't fit the LMA mould and be prepared to build bespoke solutions where our clients require them. For example, fretting about whether an RFR fits might not be necessary in some commercial contracts where LIBOR might just as easily be swapped for a simple base rate. The FCA has also raised the possibility of a synthetic LIBOR as a solution (albeit last resort) for some contracts that cannot be amended, although there is a view this might create more problems than it solves.
Finally, a reminder that the world of REF is not limited to Sterling LIBOR. While Andrew Bailey's sunset date of 2021 is most pressing, other interbank offered rates for various currencies are beginning the process of transitioning to RFRs, but they are all at different stages of development and will likely come online at different times. International co-ordination on this point appears to be in its infancy. While the work done in managing LIBOR discontinuance in the UK should prepare the ground for analogous changes, the already-diverging landscape of global currency RFRs should not be underestimated. One year on, and three years to go, the work is only just beginning.