Documenting LIBOR’s Transition to Lending Markets: LMA Offers New Solutions, But Others Likely to Follow

The latest tools from the LMA

On September 11, 2020, the LMA completed its additional exposure drafts by publishing a draft multi-currency term agreement and revolving facilities incorporating rate change provisions (the “Change of FA”). This follows a note issued by the LMA[1] defining an optional additional language (the “LMA supplement”) to be added to its existing revised clause on the replacement of screen tariffs.

Why is LMA producing these documents now?

The LMA has already increased its revised screen rate replacement clause, but the Switch FA and LMA supplement have been drafted in response to specific statements made by the UK Pound Risk-Free Benchmark Working Group (“RFRWG”). These statements[2] (the “RFRWG Statements”) made it clear that the February 2020 form of the revised on-screen pricing replacement clause[3] would not meet the RFRWG target that after the end of the third quarter of 2020, LIBOR benchmark loan products in pounds sterling should include a contractual mechanism of conversion to an appropriate rate based on SONIA or other rate without alternative risk (“RFR”). These latest LMA documents are the most recent salvo in their continued efforts to ease the market transition from LIBOR loans to alternative RFRs.

What are these new LMA documents for?

The RFRWG statements set out a range of possible approaches for parties to meet their recommendations to contractually convert a LIBOR benchmark into a replacement RFR. In fact, the Switch FA and the LMA Supplement are at different ends of the scale of documentary positions advocated in the RFRWG statements.

Pre-agreed conversion conditions

The Switch FA includes a so-called “switch” mechanism: it provides for an initial forward forward rate (like LIBOR), converted into a compound RFR upon the occurrence of a pre-granted date (which should be before the end of 2021) or as a result of a specified trigger event. A forward rate based on an RFR is not considered, as it remains to be seen if and when alternative forward rates will be available.

The FA Switch reflects the recommendations of the RFRWG issued in early September 2020[4], including the use of a retrospective analysis of five working days without an observation shift. This approach of not adopting an observation lag aligns with the ARRC strategy.[5] recommendation for US dollar loan markets but marks a possible divergence from the FRN market linked to SONIA, which currently favors the observation lag convention – see our blog post “An update on Interest rate agreements in the floating rate note linked to the SONIA Markets’ for more details on the rate agreements in the FRN sterling market. However, the RFRWG noted that a rollback with change of observation is also a viable and robust option.[6] and the LMA have confirmed that they will issue some form of tariff change agreement based on this convention shortly.

Agreed process for renegotiation

In contrast, the LMA Supplement provides for the parties to document that they will enter into good faith negotiations to agree on an alternate benchmark on a date considered sufficiently earlier than the end of 2021 to allow it. This approach therefore gives more flexibility than the FA Switch while meeting the contractual conversion objectives of the RFRWG, but therefore offers the least certainty to the parties who adopt it.

Do these LMA documents move the needle?

Arguably, the LMA supplement offers a fairly marginal change from the previous iteration of the revised screen rate replacement clause and still carries a risk of negotiation failure. The FA Switch offers a more defined path for transitioning from a LIBOR-based rate, but will require parties to agree to certain parameters around this transition at a time when uncertainty over which preferred approach remains. the loan market and other related financial markets. . As a result, the AML provides market participants with a range of options for the LIBOR transition, several of them in the form of exposure draft with a request for market participants to provide feedback with the aim of seeking clarification. focus on alternatives. This may not only be a reflection of the complex work underway to achieve a viable substitute benchmark for loan markets, but also tensions between the positions of different parties, including LMA members and the LMA. RFRWG.

Are there other solutions on the table?

Obviously, market participants have already had their own discussions and sought to document to account for the transition from LIBOR, and this will no doubt continue to happen. Likewise, these are unlikely to be the latest formulations suggested to facilitate moving parties away from LIBOR-based rates. Even with language made available to document the conversion terms in a way that will hopefully be more consistent, we would expect there to be negotiations for some time when detailing various aspects of the transactions. RFR priced deals, much like it was when LIBOR-referenced loans first emerged.