Reed Smith Client Alerts

As the cessation of the publication of LIBOR approaches at the end of 2021 (or 2023 in respect of most U.S. LIBOR rates) and with several interim deadlines in the meantime, the focus of regulators and financial market participants on the transition to Alternative Risk-Free Rates (RFRs) has intensified. The onus is on market participants to respect transition timelines and initiate the appropriate steps to ensure compliance and transition of LIBOR legacy contracts. Despite the deviation of focus away from LIBOR due to the impact of COVID-19 and the period of uncertainty it has created, the inadequacies of LIBOR have remained clear, cementing the original 2021 deadline for LIBOR’s cessation for all currencies except US Dollars.

Authors: Claude Brown Simon Hugo Andrzej Janiszewski Joe Kohler Sabah Rahman

Developments in the loan and bond markets to date

The adoption of RFRs as a replacement for LIBOR has been challenging for financial markets. To date, many developments have centred around discussions on transition after the publication of relevant documentation and guidance. As regulators have finalised their approach, financial markets are now in a position to action these developments and the onus has shifted to implementation. 

The Working Group for Sterling Risk Free Rates (UK RFRWG) has initiated this industry-led approach within UK markets, and has recommended that from the end Q1 2021, no sterling LIBOR-referencing instruments should be issued and that the identification of sterling LIBOR contracts expiring after the end of 2021 should be completed, so that active conversion can take place by the end Q3 2021. A deadline has now been set and as of 31 December 2021, GBP LIBOR may no longer be available. 

The importance of active consultation and transition has been emphasised as parties to existing LIBOR-linked bond issues have been encouraged to embark on the steps required to amend documentation. Traditional market standard fallback provisions relating to LIBOR were never designed to facilitate LIBOR’s permanent cessation. The new market convention (supported by the UK RFRWG), which has been adopted in response to the publication of GBP LIBOR no longer being guaranteed from the end of 2021, has predominantly been to reference the Sterling Overnight Index Average (SONIA) compounded in arrear over an interest period, plus an adjustment spread (in respect of legacy LIBOR-linked bonds) and lookback regarding each interest period.

International bond market participants have reacted to these timelines, and the number of RFR-linked floating rate notes issued has been growing since 2019.  

Tough legacy LIBOR

A number of LIBOR legacy contracts, referred to by the UK government as those presenting ‘insurmountable barriers’ to transition, are categorised as tough legacy1.  Such contracts are characterised by inadequate fallback provisions, making them practically difficult to amend to facilitate the impending LIBOR transition. Other contracts, for example, those requiring the consent of 75 per cent or more of noteholders for any amendments to the transaction documents, may, in practice, be difficult to amend, with any consent to transition likely to be time-consuming and have high associated costs. 

In June 2020, enhanced FCA powers to support LIBOR transition were announced to enable the FCA to intervene in situations where it considers a critical benchmark is at risk of being unrepresentative. Additionally, the FCA will be granted the ability to direct change relating to the methodology of critical benchmarks, and to extend the publication of such benchmarks for a limited period. However, the UK RFRWG has warned that such reliance on the Financial Services Bill will likely be of limited substance and suitability, requiring parties to relinquish control over the transition process. In the United States, New York state has enacted legislation that establishes a mechanism for automatically moving tough legacy contracts over to a benchmark based on the Secured Overnight Financing Rate.