For some time there has been a difference between BBA LIBOR (which is the “screen rate” in the LMA facilities agreements) and many lenders’ own cost of funds in the London interbank market. This has become so acute that many lenders are dusting off syndicated facility agreements to check if they can pass on their actual cost of funds to borrowers in place of BBA LIBOR. In an LMA facility agreement their rights are set out in the market disruption clause. Charlotte Curtis considers how the LMA clause works, the legal and practical considerations for lenders and borrowers, and how hedging and subparticipation are affected.

When will a market disruption event occur?

This will happen if:

  • it is not possible to ascertain BBA LIBOR from the screen rate, or calculate LIBOR using the facility agreement’s fallback to a reference bank LIBOR (neither of which seems to be happening in the current market); or 
  • enough lenders in a syndicate (typically between 30 and 50 per cent) notify the agent that their cost of funds exceeds LIBOR.

What happens when a market disruption event occurs?

Each lender notifies the agent of the cost of funding its participation. Each affected lender’s own cost of funds then replaces BBA LIBOR or (as applicable) reference bank LIBOR in calculating the floating rate element of interest chargeable on that lender’s participation.

Negotiating a substitute rate of interest

If the agent or the borrower so requires, following a market disruption event, they can negotiate for up to 30 days to agree a substitute basis for deciding the interest rate. Before the substitute basis takes effect, however, all lenders and the borrower must agree to its terms.

What substitute rate of interest might be used?

One possibility is to agree to use the fallback to a reference bank LIBOR calculation (which the LMA agreement already provides for where the screen rate is not available), or to agree to use an amended version of that reference bank calculation. Another might be to agree some sort of split of the difference between BBA (or reference bank) LIBOR and the affected lenders’ actual costs of funds.

Legal issues to consider following market disruption

When receiving and dealing with details of lenders’ costs of funds, the agent should always consider its duties of confidentiality. To avoid risking a breach of competition law, there should be no direct communication between syndicate banks about their cost of funds, and the agent should avoid communicating one lender’s cost of funds to another lender. All communications about costs of funds should be channelled through the agent.

Fines for breach of competition law can be significant.

Practical issues to consider following market disruption

  • Check the documents: We have assumed the use of an LMA-based facility agreement, but lenders and borrowers should always check the terms of their own agreements carefully. 
  • The agent’s role: The agent will want to examine the terms of its facility agreement to check its duties, responsibilities and protections when operating the market disruption provisions. It will also bear a significantly increased administrative burden and should check its facility agreement to see if it can charge for this. 
  • Hedging: Hedging instruments are commonly structured by reference to LIBOR. A borrower which has tried to mitigate its exposure to fluctuating LIBOR by an interest rate swap will still have to fund the “excess” over LIBOR. The market disruption clause provides the borrower with no protection from that risk. 
  • Sub-participation: A sub-participant is not the lender of record under the facility agreement. So its cost of funds would not (in any event) be relevant in deciding the rate of interest payable by the borrower. Nor would the sub-participant (on market standard terms) have any rights against the lender of record or the borrower under the market disruption clause.

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