1489313 - Hogan Lovells FIS Horizons 2021 update - Flipbook - Page 33
Financial Institutions Horizons
Amendment process: The alternative to
a hardwire approach to meet the regulators’
requirements to include language for conversion,
is to incorporate contractual provisions to amend
the agreement away from LIBOR at a future date
which falls before the end of 2021.
In the UK, this approach was the favored route
until very recently, with the LMA’s “Replacement
of Screen Rate” wording being the usual route to
achieve this for syndicated loans. On 24 August
2020, the LMA issued guidance to include new
detailed language within this provision to specify
when the parties would start good faith negotiations
to make these amendments. This change is to
ensure that the language would be construed as
an agreed contractual method of transition by the
FCA. The LMA has said that they will also shortly
be issuing a heads of terms document which will
further bolster that provision if the parties use it
to document an outline of the basis of the agreed
RFR replacement at the outset.
In order to make sure that this provision is
compatible with the new ISDA IBOR fallbacks
in cases where the loan is linked to a derivative
which incorporates the new ISDA IBOR fallbacks,
and to avoid potential interest rate mismatch,
consideration should be given as to whether, in
the case of any LIBOR rate, to include a so-called
“pre-cessation” trigger event in this drafting.
This would be in addition to the existing triggers
which (broadly) occur upon an announcement
by the benchmark administrator (or by that
administrator’s regulator) that it has, or will cease
to provide the benchmark permanently or a practice
statement from the administrator’s regulator that
the benchmark is no longer representative.
In the U.S., the ARRC amendment approach was
initially the more popular approach compared
to hardwiring, but recently with the market
coalescing around SOFR calculation conventions
following the ARRC recommendations, the
hardwire approach is gaining traction and the
working groups are proclaiming that the safer and
more robust hardwire approach is best practice.
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When should firms stop issuing new LIBORlinked loan products?
Whilst the FSB’s roadmap states that firms should
“aim to use robust alternative reference rates to
LIBOR in new contracts whatever possible” by
mid-2021 (and this broadly matches the ARRC
requirement), the £RFRWG timetable provides
for lenders and borrowers to have taken necessary
steps by the end of Q1 2021 to cease issuance of
LIBOR-linked loan products that expire after the
end of 2021.
The £RFRWG acknowledged at the start of this
year that certain cash market products are not
suited to a backwards-looking interest rate.
These include lower value loans to a wide range
of smaller borrowers, including SMEs with no
dedicated treasury function and being less able to
adapt to the technology/process changes required
to accommodate SONIA compounded in arrears
(and who value simplicity and payment certainty).
Export finance, emerging markets, retail
mortgages, trade and working capital products
(including discounting/LCs/supply chain finance)
and Islamic finance are also expected to require an
alternative rate.
To the extent that a base rate or fixed rate
is not commercially attractive, then these types
of products may require a forward-looking
“Term RFR” and such rates are currently
in development in the UK, U.S. and in Europe.
The £RFRWG published a paper in October 2020
summarizing the key attributes of “Beta versions”
of the term SONIA reference rates published by
independent benchmark administrators. It is
currently expected that discussions around the
removal of the Beta tag will happen towards the
end of this year. In the U.S., ARRC has said that it
will seek to recommend a forward-looking SOFR
term rate by the end of June next year. The FCA
has been consistently clear that term RFRs are
only appropriate for very limited types of cash
market products (both new and legacy ones) and
that outside of these categories it expects firms
to move to the more robust and transparent
compounded RFRs.
