The Loan Market Association (LMA) recently published a set of updates to their suite of syndicated loan facility documentation, and, in this note, we review the main changes of relevance to lenders and borrowers in the ship finance market.
Dean Norton and Julie Walton
The ICE Benchmark Administration Limited’s Error Policy, published in November 2014, provides for ICE LIBOR rates to be re-fixed and republished when an error occurs in the initial calculation or submission process, and is reported by 15:00 (London time) on the relevant day.
The LMA has, consequently, introduced wording to the definition of “Screen Rate” which provides the option for parties to exclude the application of a re-fixed rate, so that the originally published rate continues to apply.
Whether to insert the new wording will be a commercial decision, but for operational reasons, parties may opt to include it as any re-fixed rate will not be available until late in the day, with a cut off of 16:00 (London time).
In making a decision, parties should also consider any interest rate hedging arrangements in place, as LIBOR re- fixes may not qualify, and this would result in a mismatch of rates applying to the loan and swap documents.
Screen Rate Fallbacks
A full redraft of the “Unavailability of Screen Rate” clause has been undertaken, and now sets out two alternate waterfall provisions, both of which contain optional slot-in provisions. The first references a “Fallback Interest Period” (intended to be as short as possible) and “Historic Screen Rates” in the event that the Screen Rate is unavailable before turning to Reference Bank Rates and cost of funds. The second references straight to Reference Bank Rates before turning to the cost of funds.
Reference Banks have been afforded a number of new protections in the updates, with the aim of limiting their liability due to the administrative nature of their role, although whether the parties choose to include reference to Reference Bank Rates will be a commercial decision. The agent bank is, also, now obliged to keep Bank Reference quotes confidential.
Cost of Funds and Market Disruption
When calculating lenders’ cost of funding, it has generally been accepted that each lender would be paid a different interest rate. However, parties now have the option to introduce a weighted average rate to be applied to all lenders, which for operational reasons may appeal to agent banks.
A borrower may be required to pay a lender’s cost of funds as a result of the market disruption clause, with interest now being paid to lenders, either individually or on a weighted basis, if a specified portion of lenders notify the agent that their cost of funding “[from whatever source [the relevant Lender] may reasonably select]/[from the wholesale market for the relevant currency]” would be in excess of the agreed benchmark.
This new wording changes the trigger for a move to the cost of funds basis, as, previously, the agent had to be notified by a certain portion of lenders that the cost of “obtaining matching deposits in the [relevant inter-bank market] would be in excess of [LIBOR]”.
This change may well operate in favour of borrowers in circumstances where lenders may be able to fund at a lower rate outside the inter-bank market (and lenders would be obliged under this wording to act reasonably in selecting the source of funding).
In 2011, with Swiss Franc LIBOR being reported negative, the LMA introduced optional wording to provide that the applicable LIBOR rate could never be less than zero.
With negative LIBORs now being seen again in the markets, lenders will be reviewing LIBOR definitions in existing and new loan agreements, and reconsidering inserting the “zero floor” LMA wording.
Without such a zero floor, negative rates could erode a lender’s margin – though, it is unlikely an overall negative rate of interest would impose an obligation on a lender to pay interest to the borrower (unless the terms of the loan agreement anticipate this).
In considering the introduction of a zero floor, however, any hedging arrangements made by the borrower should be taken into account in case there were to be a mismatch of rates.