1489313 - Hogan Lovells FIS Horizons 2021 update - Flipbook - Page 32
Hogan Lovells
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Firms should now be in a position to offer
non-LIBOR linked cash market products to
their customers
In the international bond market there have
been significant volumes of new SOFR and
SONIA-linked Floating Rate Notes (FRNs);
indeed public issuances of sterling LIBOR-linked
FRNs and securitizations maturing after the end
of 2021 has all but ceased. According to the recent
newsletter from The Working Group on Sterling
Risk-Free Reference Rates (£RFRWG),
the cumulative subtotal of outstanding
SONIA-linked FRNs is 149 deals, totaling around
£64.7 billion.
The loans market is a little behind the
international bond market, largely because of the
additional structuring complexities created by loan
mechanics. The FSB’s Roadmap states that “at a
minimum” lenders should be in a position to offer
non-LIBOR linked loan products to customers by
the end of 2020.
The published timeframe of the £RFRWG set
this goal a little earlier - at the end of Q3 this year
- so this should already be in place for regulated
lenders in the UK.
The £RFRWG’s publications in September of its
recommendations based on market feedback to its
consultation on preferred SONIA compounding
methodology in the loans market and on credit
spread adjustments in the cash markets should
have helped institutions to meet this aim by
enabling them to finalize necessary changes to
their template documentation and operational
systems to cater for lending in SONIA. It has
been made clear by the working group that these
methodologies are not the only viable options,
however, and, in particular, some firms may
instead prefer to adopt an observational lag
with a shift compounding methodology. The
work currently being done by various publishers
of compounding calculation tools (as outlined
in the £RFRWG’s summary also published
in September) should also smooth transition
progress by helping to make calculation of RFR
compounded in arrears interest rates for particular
interest periods simpler and more transparent.
If a borrower does not want to take an RFR-linked
product at this stage, firms are instead able to:
•
provide products which are linked to
alternative rates, such as to a central bank base
rate or a fixed rate; or
•
(in the words of the FSB) “work with
borrowers to include language for conversion
by end 2021 for any new, or refinanced,
LIBOR referencing loans, for example if
systems are not currently ready”.
In the UK, the £RFRWG timetable provides for
regulated lenders from 1 October 2020 to include
contractual conversion mechanisms in all new or
refinanced products. This can be done in various ways.
Hardwiring a replacement rate:
The method which delivers the most certainty for
the parties is to “hardwire” into a LIBOR-linked
loan transaction a move to the appropriate RFR
(for example, for sterling that would be to
SONIA) upon the occurrence of agreed trigger
events. The Loan Market Association (LMA)
recently published an exposure draft Rate
Switch Agreement for market comments which
documents such a hardwire mechanism.
In the US, the Alternative Reference Rates
Committee (ARRC) also recommended SOFR in
arrears rate conventions and this summer issued
recommended hardwire benchmark replacement
language for bilateral loans and syndicated business
loans. The ARRC hardwiring language specifies a
switch rate for USD LIBOR which is determined
by a waterfall selection and a spread adjustment
(also determined by a waterfall selection). At the
top of that waterfall is a Term SOFR rate (being a
forward-looking rate, which as yet does not exist)
followed by daily simple SOFR in arrears for the
interest period, although ARRC acknowledges
that syndicated loans may be based on either
compounded or simple interest. On a multi-currency
loan which incorporates both SONIA and SOFR
rates, it is likely to be administratively easier to select
compounded interest for both RFRs adopting the
same compounding methodology. A hot topic in the
U.S. at the moment is whether it should be possible
for the parties after a trigger event has occurred to
later “climb up the waterfall” in order to deselect
simple SOFR in favor of a Term SOFR rate as and
when that rate becomes available.
