The Benchmarks Regulation (EU) 2016/1011 ("the Regulation") introduced a number of significant changes around benchmark rates to ensure the accuracy of European financial benchmarks. The Regulation came into effect across the EU on 1 January 2018.
LIBOR (London Inter-bank Offered Rate), the globally accepted key benchmark rate that serves as the first step to calculating interest rates for facilities denominated in sterling and a range of other currencies, will not be used after 2021. The cessation of this long-established benchmark will see it replaced by alternative, risk-free interest rates. The implementation and underlying data resources surrounding these rates are currently being addressed in currency-specific working groups.
EONIA (Euro OverNight Index Average) and EURIBOR (Euro Interbank Offered Rate) will also be transformed or replaced as neither is fully compliant with the Regulation. The Regulation requires contributors to benchmarks to follow a code of conduct to ensure the use of robust methodologies and sufficient reliable data. EURIBOR is currently undergoing reform which is being directed by the European Money Markets Institute (“EMMI”), which is developing a hybrid methodology for EURIBOR. Once finalised, EMMI will apply for European benchmark approval to the Financial Services and Markets Authority of Belgium. EMMI expects EURIBOR to transition from its current methodology to the hybrid methodology before the end of 2019.
ESTER (Euro Short-Term Rate), which is being developed by the European Central Bank, is the proposed alternative risk-free rate to EONIA. ESTER will be made available by October 2019, at the latest. The European Central Bank has already published preliminary figures, referred to as “pre-ESTER”, with the aim of reducing market uncertainty and allowing market participants to assess the suitability of the new rate. An ESTER/EONIA spread methodology is currently being considered in order to ensure a smooth and gradual transition.
In the context of multi-currency loan facility agreements already in place where LIBOR or EURIBOR are referenced, there will, in the majority of instances, also be a series of fallback provisions, such as:
“If no Screen Rate is available for the Interest Period of the Loan (the arithmetic means of the rates rounded upwards to four decimal places) as supplied to the Lender at its request by the Reference Banks as the rate at which the relevant Reference Bank believes one prime bank is quoting to another prime bank for interbank term deposits in euro within the Participating Member States for the relevant period”.
Drafting new facility agreements
Consideration should be given to whether alternative rates are required and/or available. To avoid uncertainty post 2021, an adequate and robust fair variation provision should also be inserted providing a mechanism for determining a fallback in the event that there is no adequate reference rate available.
Consideration should also be given to including supplemental language published by the LMA in December 2018. This supplemental language permits changes to a syndicated loan facility agreement relating to the replacement of a Screen Rate (and consequential changes) to be made with a varied majority. It also provides for the possibility of disenfranchising non-responding lenders with a view to avoiding deadlock in relation to such changes.
Amending or extending existing facility agreements
Consideration should be given to amending legacy loan agreements with a maturity date after 2021 that refer to LIBOR. If these agreements are not amended before the cessation of LIBOR, and no alternative basis is provided for, it could be open to disagreement and dispute as to how the applicable interest rate should be determined. The parties to the contract may be unable to perform their obligations once LIBOR has been discontinued.
As part of such consideration, questions that may be relevant include: -
- Are the parties agreeable to the insertion of alternative rates if required and available?
- Might one (or more) party prefer the uncertainty of not amending the agreement?
- Are there any ways in which the Bank (or other party) can look to push an amendment through?
If an amendment is agreed, the legal risks and implications of inserting an alternative rate should also be examined, particularly by the Bank. Replacing LIBOR with a lower risk-free rate could result in a pricing gap leaving the Bank with a reduced return. It should also be ensured that a robust fair variation provision is inserted or retained as part of any amendment to ensure, in the event that any revised mechanism agreed to meet the requirements of the parties or the Regulation post-2021 proves inadequate, a fallback can be adopted.