On 11 September 2020, the LMA added to their complement of exposure drafts by publishing a draft multicurrency term and revolving facilities agreement incorporating rate switch provisions (the "Switch FA"). This came on the heels of a note issued by the LMA1 setting out optional supplementary language (the "LMA Supplement") to be added to its existing Revised Replacement of Screen Rate Clause.
Why Is The LMA Producing These Documents Now?
The LMA has augmented its Revised Replacement of Screen Rate Clause before, but the Switch FA and the LMA Supplement were drafted in response to specific statements made by the Working Group on Sterling Risk-Free Reference Rates ("RFRWG"). Those statements2 (the "RFRWG Statements") made it clear that the February 2020 form of Revised Replacement of Screen Rate Clause3 would not satisfy the RFRWG's objective that after the end of Q3 2020, sterling LIBOR referencing loan products should include a contractual mechanism for conversion to a suitable SONIA-based, or other alternative risk-free, rate ("RFR"). These latest documents from the LMA are the most recent salvo in their ongoing efforts to facilitate the transition of the loan market away from LIBOR to alternative RFRs.
What Do These New LMA Documents Do?
The RFRWG Statements set out a range of possible approaches for parties to satisfy their recommendations for contractual conversion from a LIBOR benchmark to a replacement RFR. Effectively, the Switch FA and the LMA Supplement sit toward different ends of the scale of documentary positions advocated in the RFRWG Statements.
Pre-agreed conversion terms
The Switch FA includes a so-called "switch" mechanism: it envisages an initial forward-looking term rate (such as LIBOR), converting to a compounded RFR on the occurrence of a pre-agreed date (which should be prior to end 2021) or following a specified trigger event. A term rate based on an RFR is not contemplated, given that it remains to be seen if and when alternative term rates will become available.
The Switch FA reflects the RFRWG's recommendations issued in early September 20204, including the use of a five banking day lookback without observation shift. This approach of not adopting an observation shift aligns with the ARRC's5 recommendation for US dollar loan markets but marks a possible divergence from the SONIA-linked FRN market, which is favouring the observation shift convention for the time being - see our blog post "An update on interest rate conventions in the SONIA-linked floating rate note markets" for more discussion of rate conventions in the sterling FRN market. However, the RFRWG noted that a lookback with observation shift is also a viable and robust option6 and the LMA have confirmed they will shortly be publishing a form of the rate switch agreement based on that convention.
Agreed process for renegotiation
By contrast, the LMA Supplement provides for the parties to document that they will enter into negotiations in good faith to agree a replacement benchmark by a date considered to be sufficiently ahead of the end of 2021 to allow it. This approach therefore gives more flexibility than the Switch FA whilst still satisfying the RFRWG's contractual conversion objectives, but consequently offers the least certainty to parties adopting it.
Do These LMA Documents Move the Needle?
Arguably, the LMA Supplement offers a fairly marginal shift from the previous iteration of the Revised Replacement of Screen Rate Clause and still carries a risk of negotiations being unsuccessful. The Switch FA provides a more defined path for transition away from a LIBOR-based rate but will require parties to agree on certain parameters around that transition at a time when uncertainty as to the preferred approach remains in the loan market and in other related financial markets. As a consequence, the LMA is offering market participants a range of options for LIBOR transition, several of them in exposure draft form with a request to market participants to feedback in an effort to focus down the alternatives. This is perhaps not only a reflection of the complex ongoing work to achieve a workable replacement benchmark for the loan markets, but also the tensions between different parties' positions, including the LMA's members and the RFRWG.
Are There Any Other Solutions on the Table?
Clearly, market participants have been having their own discussions and looking to document to take into account LIBOR transition already, and no doubt that will continue to happen. Similarly, these are unlikely to be the last forms of wording suggested as a way of easing parties' path away from LIBOR-based rates. Even with language being made available to document conversion terms in what will hopefully be a more consistent way, our expectation is that there will be negotiations for some time when detailing various aspects of RFR-priced deals, much like there was when LIBOR-referenced loans first emerged.
1. "Note on the Revised Replacement of Screen Rate Clause and documentary recommendations published by the Working Group on Sterling Risk-Free Reference Rates", published by the LMA on 24 August 2020.
2. A statement by the RFRWG published in April 2020 on the impact of COVID-19 on the timeline for firms' LIBOR transition plans included a recommendation that, "After the end of Q3 2020 lenders, working with their borrowers, should include clear contractual arrangements in all new and re-financed LIBOR-referencing loan products to facilitate conversion ahead of end-2021, through pre-agreed conversion terms or an agreed process for renegotiation, to SONIA or other alternatives".
A follow-up Q&A document published by the Loan Enabler Task Force (a sub-group of the RFRWG) in July 2020 clarified that loan documentation entered into from the end of Q3 2020 should include, "[.]adoption of either pre-agreed conversion terms or an agreed process for renegotiation at a set point ahead of the end of 2021".
3. As incorporated into the LMA facility agreements on 28 February 2020.
6. See the Summary of Recommendations section in the Statement on behalf of the Working Group on Sterling Risk-Free Reference Rates - Recommendations for SONIA Loan Market Conventions, RFRWG, September 2020.
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