Recent LMA LIBOR Related Changes - Their Possible Impact On Islamic Finance Documents

At the end of last year, the Loan Market Association (LMA) updated its facility agreements, including changes to the interest rate definitions and mechanics. Many Islamic finance transactions use a conventional interest rate benchmark, such as LIBOR, to calculate the profit or variable rental. Richard de Belder and Adam Pierce explain how one of the recent LMA changes may affect those transactions.

LMA Screen Rate definition and ICE LIBOR Error Policy

One recent development that the LMA's amendments reflect is the LIBOR administrator's publication of a new "ICE LIBOR Error Policy" in November 2014. This provides that, although LIBOR will continue to be published at around 11.45am each business day, a LIBOR contributor bank (i.e. one of the banks that provide the rates on which LIBOR is calculated) can now report any error in the rate(s) it has submitted to the LIBOR administrator up to 3pm on that day. If that error impacts on what the quoted rate should have been, the LIBOR administrator will republish the rate at some point between 3pm and 4pm.

Under the ICE LIBOR Error Policy, any recalculated rate will from that point on be treated for all purposes as if it were the rate originally published. So under existing standard documentation, if LIBOR is corrected, the rate used to calculate the interest under the loan will be the corrected rate. However, the LMA has pointed out various potential problems with this approach. For example:

Agents will need to monitor any republishing of the rate, so that they can comply with their obligation to notify the other parties promptly of the interest rate that will apply to the loan. If lenders are unable to obtain funding at the republished rate, they will have less time to notify the agent that that is the case with a view to invoking the market disruption provisions. On current drafting, they have only until close of business on the day the interest rate is fixed to do so. As a result, in the "Screen Rate" definition in the LMA documents, there is now an option to exclude the effect of any "correction, recalculation or republication" of LIBOR by the LIBOR administrator, for the purposes of determining the rate used to price the loan.

This may also be relevant for other publicly quoted interest rate benchmarks. For example, the EURIBOR Code of Conduct also requires an error policy to be put in place by its Calculation Agent.

Significance in Islamic finance transactions

As in a conventional loan, the...