LIBOR Transition: Practical Implications And Issues Arising In Loan Documentation

• Published date: 28 January 2022
• Subject Matter: Finance and Banking, Financial Services, Fund Management/ REITs
• Law Firm: Matheson
• Author: Mr Patrick Molloy, Richard Kelly and Finnbahr Boyle

Introduction

One of the most important processes in financial markets in recent years has been the transition from using interbank offered rates ('IBORs') and in particular the London interbank offered rate ('LIBOR') as the interest rate benchmark, to using 'risk free' rates ('RFRs'). This culminated in the cessation of thirty-five different LIBOR rates on 31 December 2021. Publication of the 1, 3, 6 and 12-month US dollar LIBOR settings will cease immediately after 30 June 2023.

We consider below some of the practical implications of the cessation of LIBOR and some of the consequent issues for loan documentation.

Sterling Working Group Recommendations

The UK Financial Conduct Authority's ('FCA's') Sterling Working Group on UK Risk Free Rates (the 'Working Group') previously recommended conventions for referencing Sterling Overnight Interbank Average Rate ('SONIA') in loans, and SONIA remains the Working Group's recommended alternative to Sterling LIBOR. These recommendations are not binding and recognise that an alternative methodology or rate may be more appropriate or convenient in a specific situation, and that market conventions may continue to evolve over time.

The key features of SONIA as generally implemented in accordance with the Working Group recommendations are:

• Compounding in arrear, non-cumulative approach;
• Lookback without observation shift, although lookback with observation shift is seen as a robust and viable alternative and
• Credit adjustment spread ('CAS').

Approach Taken by Banks and Borrowers to These Recommendations

During 2021, we have seen documentation for a series of existing financing transactions being amended to incorporate rate switch mechanisms, whilst new financings are incorporating RFRs from the outset. This activity accelerated significantly in the last quarter of 2021 with the approaching deadline for LIBOR cessation. Frameworks are now largely in place globally, although some bank, agent and borrower systems are still being updated, for example to cater for term RFRs. Borrower engagement with the process and understanding of the issues involved has been good overall.

The market is in general following the Working Group recommendations in one form or another. While we have seen the majority of banks in the Irish market adopt the compounding in arrear, non-cumulative approach along with the lookback without observation shift, we have seen some adopt the cumulative approach (which we understand is driven by a systems requirement).

Following the transition to RFRs, the market is now entering a more practical phase of establishing new market practices and corresponding frameworks, conventions and choices. Below we...