2021 has recently been ear-marked as the date when LIBOR (also known as the London Interbank Offered Rate) will be wound down. As work starts on finding a suitable replacement rate, where does that leave loan agreements?
Until current LIBOR is permanently discontinued, the effect is negligible, as interest calculated by reference to LIBOR will still function in the same way. However, once LIBOR ceases to be permanently available, there are two key questions:
- What will replace it?
- Will lenders be able to calculate interest with certainty?
Work has started on seeking LIBOR replacements both in the UK and overseas, but that's likely to be a long process. In the meantime, interest rate calculation mechanics in loan agreements are likely to come under closer scrutiny.
A dash to re-document?
Inevitably with any major regime change, the temptation is to try and amend all documents to cover all possible future scenarios. However, whether that's necessary or desirable will really depend on what existing agreements say and the cost of that exercise. As already seen with Brexit, trying to crystal-ball gaze what LIBOR's replacement will be (and whether it will be adequate) could be fraught with uncertainty. However, leaving all of that to one side, lenders will ultimately be concerned in ensuring that:
- they still have a functioning method of interest calculation in loan agreements; and
- the calculation method doesn't result in a shortfall against a lender's true cost of funds.
Being left without either won't be palatable option.
Is any existing help at hand?
Fall-backs may already exist in some loan agreements in circumstances where LIBOR screen rate isn't available (for example LMA based documents or where required to meet internal documentation requirements). These may ultimately allow a lender to calculate interest by reference to its own rate, as long as it reflects its reasonable cost of funds, but there may be requirements to follow other rate calculations, such as historic or interpolated rates. Provisions may also differ depending on whether agreements are bilateral or syndicated.
Even where a lender has the right to charge reasonable cost of funds where LIBOR ceases to be available, there is an argument that these types of provisions were only ever intended to cover a temporary unavailability of screen rate, rather than a permanent discontinuation of LIBOR. That may lead to legal arguments regarding both the effectiveness of fall-back provisions and where charged, whether a lender's replacement cost of funds rate is 'reasonable'. Therefore, lenders may wish to consider whether they need more robust interest calculation fall-back language to deal with LIBOR phase out.
Ultimately these are common issues that will affect the whole of the market, so it will be in the interests of all concerned to reach a consensus on the most effective way of dealing with this.
What to start considering now
Where you have new or existing loan agreements that are intended to run beyond 2021:
- check whether interest calculation provisions allow for the use of an adequate fall-back rate if LIBOR ceases to be available (with an ability to charge a lender's cost of funds);
- if no fall-back rate exists, consider amending documents where possible to incorporate alternative interest calculation provisions. Care should be taken in referring to any other rate which replaces LIBOR as the sole new interest calculation reference rate. Whether or not those rates are adequate will only be known once they come into use. (By comparison, it is worth noting that when BBA LIBOR was introduced in the 1980's, it wasn't used across the board by all straightaway, so we may see a similar approach with the LIBOR replacement); and
- check where else 'LIBOR' is referenced/defined in facility agreements and other transaction documents to see whether it flows through other terms in the way that you intend. For example if default interest provisions only refer to payments calculated by reference to LIBOR screen rate, depending on the rest of the drafting, it may not be possible to make a default interest calculation once LIBOR ceases to be published.
Whether LIBOR actually falls off the screen overnight in 2021 remains to be seen. Whilst we hope that there will be an orderly phase out, there is no certainty of that, so we expect interest rate calculation provisions to come into focus more and more, as the search for a LIBOR replacement continues.