24 September, 2019
The United Kingdom’s Finance Conduct Authority (“FCA”) announced in 2017 that it will no longer encourage or compel panel banks to submit to the London Interbank Offered Rate (“LIBOR”) after 2021. This could lead to no LIBOR publication after end-2021, which would have impact on banking documentations in the Singapore loans market that either directly or indirectly reference the USD LIBOR. To support a smooth transition away from USD LIBOR, the Alternative Reference Rate Committee (“ARRC”) has published its recommended fallback language (comprising both a hardwired approach and an amendment approach) for loans that are based on USD LIBOR. Separately, the Monetary Authority of Singapore (“MAS”) has recently convened a steering committee to oversee an industry-wide interest rate benchmark transition from Swap Offer Rate (“SOR”), which uses USD LIBOR as an input in its computation, to Singapore Overnight Rate Average (“SORA”).
Loan contracts that directly reference USD LIBOR
The ARRC, convened by the Federal Reserve Bank of New York (“FEDNY”) to identify an alternative reference rate for USD LIBOR, had in June 2017 selected Secured Overnight Financing Rate (“SOFR”)1 as its recommended alternative to USD LIBOR. The ARRC had said that it does not recommend waiting until a forward-looking term SOFR, which may only be produced at the end of 2021, before transitioning.2 Likewise, the Chief Executive of the FCA had said that it is a “mistake” for any firm to delay transition until term rates arrive.3
As such, the Chief Executive of the FCA had suggested market participants to carefully consider their fallback provisions to the extent that LIBOR (including USD LIBOR) continues to be used in new loan contracts, or can be practicably added to existing loan contracts.4
At present, there are generally two types of benchmark replacement approaches:
(a) “hardwired approach”- which would implement a benchmark replacement based on pre-agreed triggers, terms and conditions without need for future negotiation or selection; and
(b) “amendment approach”- which would require the parties to negotiate and/or select a replacement reference rate in the future.
The ARRC has published its recommended hardwired approach fallback language (“ARRC Hardwired Approach”) and amendment approach fallback language (“ARRC Amendment Approach”) in May 2019.5 Separately, the Loan Markets Association (“LMA”) has published its version of the recommended revised form of replacement screen rate clause, which is based on the amendment approach, in December 2018 (“LMA Amendment Approach”).6
(a) ARRC Hardwired Approach vs ARRC Amendment Approach
The ARRC Hardwired Approach and ARRC Amendment Approach share the same triggers (permanent cessation trigger, pre-cessation trigger – the benchmark is “no longer representative”, and early “opt-in” trigger) that will precipitate the transition away from USD LIBOR.
One main difference between the two is the successor replacement benchmark to be used.
The ARRC Hardwired Approach follows a waterfall methodology whereby the replacement benchmark will be selected in the following order: (1a) term SOFR + spread adjustment7, (1b) next available term SOFR + spread adjustment, (2) compounded/ simple SOFR + spread adjustment, and (3) streamlined amendment process. Term SOFR is a forward looking rate that will be selected by the Federal Reserve Board and/or the FEDNY. Compounded/simple SOFRs are backward looking rates compounded/aggregated over the relevant period. The final step of the waterfall is an escape hatch that allows easier transition from USD LIBOR in the event that the earlier steps do not produce a usable rate.
On the other hand, the ARRC Amendment Approach does not specify what the successor rate would be. Instead, it provides a streamlined amendment process for selecting and negotiating a benchmark replacement in the future. This selection has to give due consideration to any selection or recommendation of a replacement benchmark by the relevant government body or any evolving or prevailing market convention.
It is important to note that step (3) of the waterfall methodology of the ARRC Hardwired Approach also features a streamlined amendment approach.
(b) ARRC Amendment Approach vs LMA Amendment Approach
There are various differences between the ARRC Amendment Approach and the LMA Amendment Approach.
First, the trigger event for the replacement benchmark is different in certain aspects. While both amendment approaches contain permanent cessation triggers 8 , there is no explicit pre-cessation trigger 9 in the LMA Amendment Approach, unlike the ARRC Amendment Approach. 10 Also the early opt-in trigger differs between the two. While the LMA Amendment Approach requires both the lenders11 and the obligors to find that the existing rate is inappropriate, the ARRC Amendment Approach for bilateral loans allows the lender to unilaterally trigger the replacement benchmark and the right of the borrower to object is an optional language.12 However, it is noted that the early opt-in trigger for the ARRC Amendment Approach for syndicated loans is only successful if agreed by the borrower and administrative agent, and not objected to by a required lenders vote.
Secondly, the replacement benchmark selection process is different between the two. While the LMA Amendment Approach requires agreement of both the lenders and the obligors, the ARRC Amendment Approach for bilateral loans allows the lender to unilaterally decide the replacement benchmark to be selected and the right of the borrower to object is an optional language.13 However, it is noted that the ARRC Amendment Approach for syndicated loans requires the replacement benchmark to be selected by both the administrative agent and the borrower.
Additionally, the ARRC Amendment Approach is more detailed than the LMA Amendment Approach. For instance, the ARRC Amendment Approach includes provisions for conforming changes,14 notices of changes,15 and the effect during the benchmark unavailability period.16
Loan contracts that indirectly reference USD LIBOR
Additionally, market participants should also consider the risks of using the SGD SOR, which uses USD LIBOR as an input in its computation, given the likely discontinuation of USD LIBOR after end-2021.
MAS has announced the establishment of the Steering Committee for SOR Transition to SORA on 30 August 2019, to oversee an industry-wide interest rate benchmark transition from SOR to SORA. SORA reflects the volume- weighted average rate of all unsecured overnight interbank SGD transactions brokered in Singapore between 9:00 am to 6:15 pm, and is a reflection of daily conditions in the SGD money markets.
The Association of Banks in Singapore and Singapore Foreign Exchange Market Committee (“ABS-SFEMC”) has said that it is envisaged that firms will need to actively transition out of contracts that reference SOR, for example by changing the contract’s reference rate from SOR to alternative SGD interest rate benchmarks like the Singapore Interbank Offered Rate (“SIBOR”) or SORA.17 The ABS-SFEMC had recommended that the SGD cash markets could continue to use multiple rates as is the case today, where various interest rates (eg SORA, SIBOR, bank deposit/board rates) would coexist as reference rate.
The ABS-SFEMC had suggested that SORA-based cash products would benefit from being perfectly hedged using SORA-based derivatives, which would reduce the basis risk for users. Nevertheless, it acknowledged that many cash market participants are currently more operationally familiar with a forward-looking term interest rate and recognises that SIBOR would continue to be a relevant reference rate for cash markets in the near and medium term.
Conclusion
The impending discontinuation of USD LIBOR will impact financing structures and documentation that either directly or indirectly reference USD LIBOR. In order to ensure a smooth transition away from USD LIBOR, lenders and borrowers should start to consider the various options mentioned above or other bespoke options in relation to existing and future loan structures. At the same time, they should also keep track of market developments on this which will continue to evolve over time.
1 SOFR is a broad measure of the cost of borrowing cash overnight collateralised by the U.S. Treasury Securities.
2 ARRC Recommendations Regarding More Robust Fallback Language For New Originations Of LIBOR Bilateral Business Loans (30 May 2019) (ARRC Bilateral Loans Recommendation), page 3. See also ARRC Recommendations Regarding More Robust Fallback Language For New Originations Of LIBOR Syndicated Loans (25 May 2019) (ARRC Syndicated Loans Recommendation). While the ARRC had separate guides for syndicated business loans and bilateral business loans, for ease of discussion, this client update will make reference primarily to the guide for bilateral business loans, unless there are significant divergence between the two.
3 FCA – LIBOR Preparing For The End (15 July 2019) (FCA CEO Speech), point 5.
4 FCA CEO Speech, point 6.
5 ARRC Bilateral Loans Recommendation, page 4 and 7.
6 LMA – The Recommended Revised Form of Replacement Screen Rate Clause and Users Guide (21 December 2018) (LMA Replacement Screen Rate Guide), page 7; also see our publication in October 2018 titled “LIBOR and SIBOR reform – Impact on Rate Fixing and Banking Documentation”.
7 Given that LIBOR and SOFR are different rates (eg LIBOR is based on unsecured transactions while SOFR is based on secured transactions), the transition from USD LIBOR to SOFR requires a spread adjustment to make the rate levels more comparable. See ARRC Bilateral Loans Recommendation, page 26.
8 Public statement or publication of information that the actual cessation of LIBOR has occurred or is expected by the administrator/ regulatory supervisor for the administrator of LIBOR.
9 Public statement by the regulatory supervisor for the administrator of the Benchmark announcing that the LIBOR is no longer representative.
10 However, the LMA Amendment Approach includes the trigger when the administrator of the screen rate determines that it should be calculated in accordance with its reduced submissions or other contingency or fallback policies or arrangements.
11 In relation to syndicated lending, LMA said that the parties should insert the consent level that is appropriate in the context of the composition of the lending group.
12 The right for the borrower to object is in placeholders in the recommended clause. However, note that the lender’s unilateral right is constrained by the need for the lender to determine that there is a certain number of USD syndicated or bilateral credit facilities containing a new benchmark interest rate to replace LIBOR.
13 The right for the borrower to object is in placeholders in the recommended clause; Note however that the lender’s unilateral right is constrained by the need to give due consideration to the replacement benchmark selected or recommended by the relevant government body, the evolving or prevailing market convention.
14 Technical, administrative or operational changes to reflect the adoption and implementation of the benchmark replacement.
15 Certain situations whereby the administrative agent has to give notices to the borrower and/or lender.
16The effect during the period before an amendment selecting the benchmark replacement is made effective. During this period, the outstanding loans (and new loans) will accrue interest at the Alternate Base Rate, which is typically defined in credit agreements as the highest of (x) Prime Rate, (y) Federal Funds Rate + 0.50% and (z) 1-month LIBOR + 1% (prong (z) would be disregarded if LIBOR is no longer available).
17 ABS-SFEMC – Roadmap for Transition of Interest Rate Benchmarks From SGD Swap Offer Rate (SOR) to Singapore Overnight Rate Average (SORA) (30 August 2019) (ABS-SFEMC SORA Roadmap), page 22.
