October 30, 2018 - In September the Alternative Reference Rates Committee (the ARRC) released a consultation on LIBOR fallback language for syndicated loans. On October 4th, the LSTA hosted a webcast that detailed the consultation. We also are releasing a series of briefs that explain the fallback proposals and consultation questions to help market participants develop their responses (which are due by November 8th).
The LSTA first focused on the triggers that initiate the transition from LIBOR to a new reference rate. Next we focused on one of the two fallback approaches proposed in the consultation – the hardwired approach. The hardwired approach, if adopted, would be a new step for the loan market. This approach gives up flexibility but offers a set of predetermined terms for a transition away from LIBOR, which allows for more certainty, less gamesmanship and reduces the operational burden of transition. This week, we examine the second fallback approach proposed in the consultation – the amendment approach. (The amendment approach fallback language is set forth in Appendix I of the consultation and is explained starting at minute 18:31 of the LSTA webcast.)
The amendment approach does not prescribe what the replacement rate (or spread adjustment) would be, rather it provides a streamlined amendment mechanism for negotiating a replacement benchmark in the future and is similar to the “LIBOR replacement” language that has been included in 2018 credit agreements. Unlike many cash products, syndicated loans are flexible and often are amended or refinanced over their lifetime. Recognizing this fact, the syndicated loan market has looked to an amendment approach as a preliminary solution for choosing a LIBOR replacement. The amendment approach included in the consultation builds on this language and includes specificity around trigger events, an explicit inclusion of a replacement spread adjustment and an objection right for the majority of lenders (as discussed below). Like the hardwired approach, there are certainly pros and cons. This approach does not need to rely on any terms that do not yet exist (e.g. Term SOFR or Compounded SOFR) because it allows for the decisions on replacement rates and spread adjustments to be made in the future. At that time, market participants will have more information about term SOFR rates and credit spread methodologies. In fact, some market participants may see the amendment approach as an initial step towards adopting a hardwired approach when more information is available.
The flip side of this approach’s flexibility, however, means that amendments to select a replacement rate will be needed in the future. From an operational perspective, it could be very challenging to simultaneously amend thousands of loans due to an unexpected LIBOR cessation. This could create the very real possibility of disruption in the loan market. Additionally, the amendment approach is likely to create winners and losers in different market cycles. Market participants will need to carefully consider the pros and cons of both approaches and market participants’ views on which approach they prefer are solicited in the very first consultation question (minute 27:40 of the webcast). Question 1 asks the fundamental question of which approach the respondent believes is the appropriate policy choice for the ARRC recommendation. Respondents who advocate for the amendment approach are further asked what specific information (for instance, existence of term SOFR) they would need to adopt a hardwired approach.
Moving on from philosophy, we now look at how the amendment approach works:
As discussed in our first brief, there are five mandatory triggers that start the conversion process from LIBOR to the new reference rate. They are triggers that indicate LIBOR cessation, an unannounced stop to LIBOR, a decline in the number of banks that make LIBOR submissions or the relevant regulator saying that LIBOR may no longer be used. These triggers are more specific than those being seen in the market today and, in the amendment approach, could be determined by the administrative agent, the borrower or required lenders. There is also an early “opt-in” trigger that allows for a transition away from LIBOR if the administrative agent determines or required lenders determine that new or amended loans are incorporating a LIBOR replacement.
Once a trigger event has occurred, the borrower and the administrative agent select a replacement rate (which may include, but need not be, a SOFR term rate) and a spread adjustment or “Replacement Benchmark Spread”, if necessary (the rate and spread together being the “Replacement Benchmark”). In their selection of the Replacement Benchmark, they are required to give due consideration to any evolving or then existing market convention for U.S. dollar syndicated loans or any selection or recommendation by the Fed or the ARRC. (See clause (a) of the section titled “Effect of Benchmark Discontinuance Event” and the “Replacement Benchmark Spread” definition.) Once the selection has been made, the administrative agent provides notice to the lenders of the proposed replacement benchmark. If the amendment is a result of a mandatory trigger, the lenders then have the opportunity to object to the rate and, if a majority of the lenders object to the amendment, the amendment fails. (See clause (A) of the “Benchmark Transition Determination” definition and clause (b) of the section titled “Effect of Benchmark Discontinuance Event”.) The loan would then accrue interest at the alternate base rate until a replacement rate is successfully chosen. (See clause (c) of the section “Effect of Benchmark Discontinuance Event” and the “Benchmark Unavailability Period” definition.) Alternatively, if the amendment is a result of the early “opt-in” trigger, then upon notice by the agent of the proposed replacement benchmark, a majority of lenders would have to affirmatively accept the rate for the amendment to be effective. (See clause (B) of the “Benchmark Transition Determination” definition and clause (b) of the section titled “Effect of Benchmark Discontinuance Event”.)
Because the amendment approach leaves most of the replacement rate substance to be decided in the future, there are not as many consultation questions devoted to the amendment approach. However, there are several important questions on lender vote thresholds, administrative agent discretion and operational concerns. Question 15 asks for respondents’ views on how much discretion the lenders should have (starting at minute 38:55 of the webcast). As used in the fallback proposals, a class vote means that for an objection or an affirmative consent to be valid, each class of loans in the credit agreement (e.g. revolver lenders may be one class, term loan B lenders another class) must give their objection or consent, respectively. Question 15(a) asks whether, with respect to an amendment following a mandatory trigger, the objection to the replacement rate by the required lenders should be by class, i.e. that each class must object to the replacement rate for the amendment to fail. Similarly, Question 15(b) asks whether, with respect to an amendment following an early “opt-in” trigger, the affirmative consent to the replacement rate by the required lenders should be by class, i.e. that each class must accept the replacement rate for the amendment to be successful. Furthermore, is affirmative consent the proper threshold for an early “opt-in”, or would lenders having an objection right be sufficient? The last two sets of questions are particularly relevant for administrative agents (starting at minute 41:25 of the webcast). Under both proposals, the administrative agent is involved in selecting and administering the replacement rate, but the administrative agent exercises more discretion under the amendment approach because the replacement rate and spread adjustment are not pre-determined. Question 17 asks whether administrative agents would be willing to (i) work with the borrower to identify a new reference rate or spread adjustment, (ii) determine whether triggers have occurred, (iii) select screen rates where reference rates are to be found, and (iv) execute one-time or periodic technical or operational amendments to allow the administrative agent to appropriately administer the replacement benchmark. Finally, Question 21 invites all respondents to share any operational concerns they may have with the ability to convert many loans over a short period of time. This question is particularly important for market participants to consider in the context of the amendment approach.
Make your voice heard!
The results of this consultation will inform the ultimate recommended language published by the ARRC. We remind all loan market stakeholders (borrowers, agents, lenders) that responding to this consultation is your best opportunity to influence a future LIBOR transition. Feedback to email@example.com is requested by Thursday, November 8th (one response per institution; anonymity available upon request).
This note on fallback triggers is the third in a series of spotlights on the ARRC’s Syndicated Loans Consultation. Click here for a high-level summary of the entire consultation and here for our consultation webcast.