The FSB, currently underway in the UK Parliament, will provide a framework to facilitate the transition of financial products referencing LIBOR to other benchmarks where there are obstacles to such a transition before the end of 2021.

However, lenders and borrowers should not rely on these fallback arrangements, as it could mean they lose control over the deals they make. Instead, companies should see the FSB as an incentive to retain control over their transition, even in the context of “hardened” loan agreements referencing LIBOR where parties may find it difficult to agree on. an approach.

LIBOR and the impact of the FSB

LIBOR is a measure of the average rate at which banks are willing to borrow certain funds and is used as a pricing mechanism for financial products. But following scandals over its manipulation, regulators and banks have agreed to stop supporting the rate at the end of 2021. Businesses are expected to adopt alternatives by then.

Recognizing that the transition away from LIBOR is not always straightforward, the UK government included proposals in the FSB that would take effect in the event companies cannot agree on the way forward.

In its current form, the FSB would allow the Financial Conduct Authority (FCA) to:

• restrict the use of certain benchmarks, including LIBOR;
• require changes to the methodologies of these references, and;
• allow these amended references to apply to certain existing agreements.

This is intended to provide a fallback framework to facilitate the transition from financial products that benchmark LIBOR to other benchmarks when there are obstacles to such a transition taking place before the end of 2021. Among financial products for which the FSB is relevant are loan agreements referring to LIBOR.

What are “hardened” agreements?

FCA recently referred to difficult legacy deals such as those under which “the critical benchmark is referenced in contracts and / or instruments that can hardly be moved away from the benchmark rate by actions or agreements by or between the contract counterparties themselves… “.

“Hardened” loan agreements can have some of the following characteristics:

• they do not contain adequate fallback solutions for screen rate replacements;
• they require the consent of all lenders and borrowers and / or;
• borrowers under this loan agreement may not focus on LIBOR transition issues and may be reluctant to accept changes to loan documentation.

What are the loan agreement proposals that refer to LIBOR?

With regard to loan agreements that refer to LIBOR, the main FSB proposals provide that the FCA will be able to:

• “Designate” – that is to say prohibit the use by supervised entities of – critical benchmarks which risk becoming unrepresentative or have become unrepresentative and whose representativeness of this benchmark cannot reasonably be maintained or restored;
• order the benchmark administrator of a designated benchmark to change the methodology of a designated benchmark, to extend the use of the changed benchmark for a limited period until 10 years and allow the use of the modified benchmark with respect to certain inherited agreements concluded by supervised entities (the inherited power).

Outstanding issues following the proposals

What methodology would be used to calculate LIBOR if it were a designated benchmark?

The FCA has set out principles it could follow in changing a designated benchmark, but there is currently little certainty as to how the rate might be calculated in practice or what its implication might be on the economics of transactions in practice. general.

Will all LIBOR-tenor-currency combinations be covered?

No, for example, the FCA recently indicated that it does not currently plan to exercise the inherited power with respect to Euro LIBOR or Swiss LIBOR and cannot do so with respect to sterling-tenor combinations which are not “widely used”. Whether or not a LIBOR contract is heavily used is up to the FCA. He is expected to make an announcement regarding Yen LIBOR and Dollar LIBOR in the coming months.

Loan agreements that use LIBOR benchmarks, where the benchmark is less prevalent, may therefore not be covered by legacy power, putting them at risk of not performing well after the end of 2021. due to the lack of a benchmark. This will be relevant for arrangements such as multi-currency working capital facilities.

What happens when different jurisdictions take different approaches to a designated benchmark?

As the FMLC noted “[w]Much of the work on successor rates for the different LIBOR benchmark currencies has been ‘re-installed’ in jurisdictions and / or regions in which the relevant currencies are sovereign legal tender, ‘but the FCA may determine its own version, for example, dollar LIBOR or yen LIBOR.

Although the FCA has indicated that it intends to consult with other regulatory and supervisory bodies, lenders and borrowers will need to be aware that the law applicable to their loan agreement can lead to different results in the process. adoption or implementation of successor LIBOR rates by the operation of according to the approach of the regulators of the jurisdictions concerned.

What happens to the facility coverage?

If the inherited power is not applied consistently between LIBOR-referenced loan agreements and facility interest coverage, this can create practical difficulties in covering exposures under legacy LIBOR loan agreements afterwards. 2021.

What does this mean for those who rely on the FSB’s “hardened” proposals?

FSB may be more useful in simpler bilateral loan agreements that refer to commonly used LIBOR-tenor-currency combinations, where the agreement has not been changed because the parties to the transaction have not agreed. of an approach. For more complex loan agreements, the parties to the transaction are likely to take proactive steps to move these agreements away from LIBOR.

Perhaps the greatest current value of the FSB’s proposals is the impetus they should give to parties to transition from legacy LIBOR loan agreements, even those where “hardened” proposals might otherwise apply. This will ensure that the parties can choose the outcome they want rather than letting the CAF restrict the choice for them. Parties should avoid relying on the FSB and continue their efforts to move away from LIBOR before the end of 2021.