LIBOR update: key information for borrower clients

There is no intention to extend the end date for LIBOR discontinuation beyond 2021. Here, we summarise recent developments and implications for borrowers.

In our last update in February 2020, we discussed the fact that LIBOR, the London Interbank Offered Rate is to be discontinued from the end of 2021. The government, the Financial Conduct Authority (FCA) and the Bank of England (BoE) have confirmed that, despite the upheaval caused by COVID-19, they have no intention of extending this hard end date for LIBOR discontinuation. Following on from our last update, we briefly summarise recent developments and implications for borrowers.

Proposed new timeline

Although the date for the cessation of LIBOR (end of Q4 2021) has not changed, certain key milestones have been extended. The proposed new timeline is:

• By the end of Q3 2020
  • Non-LIBOR products should be offered by lenders – the most likely alternative rate is SONIA, the Sterling Overnight Indexed Average which is discussed in more detail below.
  • LIBOR loans should provide an alternative rate (either by setting out the conversion terms or the renegotiation process for transitioning away from LIBOR) and specify the date on which the loan will transfer to the alternative rate or set out the trigger events for the switch.
• By the end of Q1 2021
  • No new sterling LIBOR-referencing loan products that would expire after the end of 2021 should be issued.

The latest update on SONIA

SONIA is a sterling risk-free rate calculated using a different, more robust method to LIBOR and is the preferred replacement for LIBOR. There are different ways to calculate SONIA, but it is likely that the market will prefer one of two ways: compounded SONIA daily rate or the term SONIA rate.

Compounded SONIA daily rate is the most likely alternative rate to be adopted by lenders. It is expected to be suitable for 90% (by value) of the LIBOR loan market which represents larger value loans to bigger borrowers. However, the rate does not allow for accurate forecasting and budgeting so may prove unpopular with borrowers. The BoE began publishing the SONIA Compounded Index from 3 August 2020 which simplifies the calculation of compounded interest rates and subsequently acts as the official standardised platform.

The term SONIA rate which would be appropriate for the remaining proportion of the market, made up of lower value loans to smaller borrowers, is not yet available due to the impact of the coronavirus pandemic and may not be widely utilised once developed. Subsequently, fixed rates or the BoE’s base rate may be relied upon to replace LIBOR in such instances.

New legislation for tough legacy loans

Inevitably, there will be existing LIBOR contracts which expire after the end of 2021 and are unable to convert to an alternative rate and/or cannot realistically be amended or negotiated. To deal with these tough legacy loans, the government is expected to broaden the powers of the FCA in relation to the frameworks which govern benchmarks, allowing, for example, LIBOR to be calculated by reference to a risk free rate, rather than bank panel submissions.

This may be useful during the wind-down period as it may allow for very limited continued use of this “synthetic LIBOR” in circumstances where there is genuinely no alternative. The FCA has warned, however, that such contracts will be very much the exception and therefore work to move away from LIBOR should continue wherever possible.

Guidance from the Loan Market Association (LMA)

While the market firms up conventions for SONIA, the LMA and other stakeholders continue to work toward achieving a market standard for transition wording in loan documentation. On 24 August 2020 the LMA published an update to its suggested replacement rate wording (which was incorporated into the LMA facility agreements as of 28 February 2020).

The revised wording satisfies documentary guidance from the Working Group on Sterling Risk-Free Reference Rates, which specified that agreements should either adopt pre-agreed conversion terms or include an agreed process for negotiation ahead of the 2021 deadline. The supplement takes the latter route, which, it is acknowledged, is at the end of the spectrum which provides least certainty to the parties involved. Guidance notes are available on the LMA website.

Take home message for borrowers

1. LIBOR cessation is still expected for the end of Q4 2021 (despite the current coronavirus pandemic).
2. Borrowers should consider their current documentation and how it deals with LIBOR transition (if at all) and take advice as to how and when they should seek to transition away from LIBOR.
3. “Tough legacy” loan borrowers should consider the economic suitability of synthetic LIBOR for their business and discuss options with their lenders.