Legal Update – the slow death of LIBOR and its proposed replacement

The London Inter-bank Offered Rate (“LIBOR”) is an unsecured interbank rate used as an interest rate benchmark for trillions of dollars of deals globally, including corporate loans, which fell into disrepute several years ago due to a rate-rigging scandal.  

On 27 July 2017, the Financial Conduct Authority (the “FCA”), announced that by the end of 2021, the FCA will not use its legal powers to compel or persuade banks to submit to LIBOR as they are not comfortable in doing so where there are only a few eligible term borrowing transactions by large banks.  

The FCA’s CEO described this decision as “potentially unsustainable, but also undesirable, for market participants to rely indefinitely on reference rates that do not have active underlying markets to support them”.

However, it is not necessarily the case that LIBOR will be discontinued. The LIBOR Administrator has indicated it will continue producing LIBOR despite the FCA’s decision, and, as such, it appears likely that LIBOR will not continue in its current form, particularly as the ICE Benchmark Administration published a consultation paper on 12 April 2018 on a revised version of the LIBOR code of conduct. The revised code is intended to clarify the framework within which banks supply data to LIBOR. Instead, the reformed Sterling Overnight Index Average (“SONIA”) will replace LIBOR as the preferred short-term interest rate benchmark in the UK.

Replacement of LIBOR

The Bank of England (“BoE”) set up the Sterling Risk-Free Rate Working Group to review LIBOR alternatives and recommend a preferred near risk-free reference rate.  On 28 April 2017, the BoE proposed to replace LIBOR with reformed SONIA, which is administered by the BoE.  Reformed SONIA will collect information on unsecured overnight lending transactions between banks and those arranged by brokers for sums exceeding £25 million.  After discarding outliers, the rate will be published the following day at 9 am.  A similar process is used to calculate benchmarks in Europe and Japan, called EONIA and TONAR respectively, both of which are also based on unsecured lending.  The anticipation is that reformed SONIA will be implemented on 23 April 2018.

Implications for existing loan documentation and drafting new loan documentation

Most existing forms of loan documentation in the UK are based on Loan Market Association (“LMA”) facility documentation.  Currently, LMA facility documentation sets out that, subject to negotiation, in the absence of LIBOR, floating interest rates can be determined based on rates provided by a pre-agreed set of Reference Banks. Failing that, each lender can self-certify its cost of funds.  However, these are fallback positions intended for short-term issues with the availability of LIBOR.  In the long term, it would be up to the parties to the loan facility to agree on a replacement rate.

At this stage, you should review existing loans tied to LIBOR to determine if the loan documentation includes language that provides for the application of an alternate rate in the event LIBOR discontinues.  If not, it may well be the case that you need to amend existing loan documentation to tie to a new interest rate. 

For currently drafted loan documentation that is expected to remain in place after LIBOR ceases to exist/its widespread use ceases, the parties should contemplate using SONIA (which as discussed before, is the likely alternative to LIBOR) or set out procedures for such a rate by the end of 2021 – once the FCA no longer compel any bank to submit to LIBOR. Notwithstanding intra-group loan agreements, the LMA’s stance on LIBOR may largely influence the facility documentation, and the development of such will be interesting to following over the next few years.

Further information

Please contact Rishi Sarin or Louise Mookerjee.

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