Reed Smith Client Alerts

As announced on 27 July 2017 by Andrew Bailey, the then Chief Executive of the UK Financial Conduct Authority, market participants should not rely on LIBOR being available after 2021. The transition of market participants from the current London Interbank Offered Rates (LIBORs) to alternative risk-free reference rates (RFRs) has slowed due to the COVID-19 pandemic, resulting in the Bank of England’s Working Group on Sterling Risk-Free Reference Rates (Working Group) acknowledging that an amended timeline and approach were necessary.

In July 2020, the Working Group published an updated road map for LIBOR transition, which requires lenders to offer their customers alternative interest rates to LIBOR for new loans from 1 October 2020. For example, alternative rates to LIBOR in sterling loans could include the Sterling Overnight Interbank Average rate or a fixed rate of interest. If a customer nevertheless chooses a LIBOR rate to apply to a loan, rather than an alternative interest rate, the Working Group has made it clear that contractual mechanisms are to be included in their loan documentation that will facilitate LIBOR’s conversion to a suitable RFR before the end of 2021. Although such contractual mechanisms would preferably take the form of pre-agreed conversion terms, it is appreciated that such an arrangement will not always be possible, depending as it does on various operational constraints on market participants. In such instances, an agreed process for renegotiation should be included in the loan documents, together with a timeline for the future transition to conversion terms agreed between the parties.

To aid borrowers and lenders in making this transition, the Loan Market Association (LMA) has recently published the additional documentation set out below. It should be noted that the LMA plans to update this various documentation over time, based on market feedback, and so the information provided here is accurate as at 29 September 2020.

Pre-agreed conversion terms – the Rate Switch Agreement

The LMA has published an exposure draft of a multicurrency term and revolving facilities agreement (Rate Switch Agreement), which incorporates rate switch provisions. Once adopted by parties, the Rate Switch Agreement will enable borrowers and lenders to enter into transactions based on current LIBOR benchmarks that will transition in due course to compounded RFRs.

Key components of the Rate Switch Agreement include:

1. Rate switch provisions

The Rate Switch Agreement contains a new mechanism, the ‘Rate Switch’ clause, which allows the reference rate for a specific currency to change to a compounded RFR by way of the following:

  • Rate Switch Trigger Events – are objectively determined events that lead to current benchmarks becoming unsuitable for use or ceasing to exist. A public announcement from a regulatory authority regarding current benchmarks, for example, would constitute a Rate Switch Trigger Event. The occurrence of a Rate Switch Trigger Event will result in the Rate Switch Date, as detailed below. It should be noted that although the Rate Switch Trigger Events are intended to address the same events as the analogous provisions in documentation for other products (for example, ISDA’s derivatives documentation), parties should ensure that where there are interlinked products on transactions, such trigger events should match appropriately to ensure that transition of linked products occurs concurrently.
  • Rate Switch Date – is the date on which the change to a compounded RFR will occur, and is triggered by the Rate Switch Trigger Event. While such provisions should contain a ‘backstop’ date to ensure that the transition occurs prior to the end of 2021, they should be adapted to anticipate the levels of operational readiness, which may be unknown at the time of their incorporation into loan documents and should therefore allow for deferrals or limited time extensions.