Implications of the LIBOR transition for Corporate Service Providers

27 April 2021 Reed Smith Client Alerts

Page d'accueil Perspectives Implications of the LIBOR transition for Corporate Service Providers

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.

Auteurs: Claude Brown Simon Hugo Andrzej Janiszewski

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.

Action required by Corporate Services Providers

A proactive approach is required from market principals operating under LIBOR-linked documentation. Transactions must be reviewed to ascertain whether they will be able to function post-LIBOR transition, and if this is possible, to determine whether interest rates will become unrepresentative. Engaging with noteholders at an early stage is the sensible approach to LIBOR transition, ensuring that transactions can be reviewed and then amended accordingly to account for LIBOR’s cessation. This, in turn, will highlight tough legacy contracts that warrant further attention.

The UK RFRWG has made clear that transactions must be reviewed on an individual basis. Consent solicitations, the costs associated with them and the timing of their passing must all be considerations. Fee incentives are not deemed appropriate when obtaining the prerequisite consent from noteholders. The Association for Financial Markets in Europe (AMFE) has issued fallback language providing that if a trigger event were to occur, note trustees and issuers may amend benchmark rates without noteholder consent, unless 10 per cent of the most senior class of noteholders objects to such amendments. However, the adoption of such language into existing transactions still requires an amendment to the relevant transaction documents. Trigger events under such guidance include a material disruption or change to the current benchmark rate. This highlights how provisions have been built into documentation, but such provisions need to be acted upon in order to become beneficial.

Regarding the content of LIBOR amendments, parties are encouraged to consider including robust fallback language in both legacy and new contracts, accompanied by both pre and post-cessation triggers. Timing of triggers must be uniform and consistent across contracts that are linked, and measures maintained to avoid conflicts of interest and comply with requirements around treating customers fairly.

Conclusion

Conducting noteholder identification and the resulting consent solicitation procedure required to amend documentation is undoubtedly cumbersome. Obtaining the consent of multiple transaction parties, including multiple classes of noteholders, and combining this task with obtaining rating agency confirmation can be a momentous task.

Further, action may be required to avoid transaction parties finding themselves caught between restrictions relating to documentation amendment, and ongoing obligations to administer the underlying asset and note payments. Internal processes also need to be in place to calculate such payments under the new RFR prior to implementation. This will be a time-consuming process from both a consent and an operational perspective. Therefore, the amendment process, particularly in potentially tough legacy contracts, needs to be commenced in a timely fashion, allowing for delays and complications.

LIBOR Policy Statement, 21 October 2020.

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