May 27, 2020 - While COVID-19 has been absorbing nearly all mind space, we cannot forget that there are just 19 months before LIBOR may become unusable. Remember that submitting banks have not committed to providing LIBOR submissions after 12.31.21 and, unless they do so, we cannot rely on LIBOR past that date. So how do we get off LIBOR in time? The ARRC just released a series of Best Practice Recommendations and timeline to help achieve this critical goal.
There are four best practice recommendations for new business loans and refinancings, including ceasing LIBOR loan originations in mid-2021. The recommendations build upon each other and align with the ARRC’s Objectives. Below, we explore the recommendations, their rationales and preconditions.
- Recommendation 1: To the extent not already utilized, all new business loans should include ARRC-recommended (or substantially similar) hardwired USD LIBOR fallback language as soon as possible, but in no event later than September 30, 2020. Rationale: There are more than 10,000 syndicated loans outstanding, so executing a large number of amendment fallbacks even in a benign market would be challenging. (And markets may well be unsettled when LIBOR ends; imagine attempting to execute 10,000 fallback amendments in a market disruption akin to March 2020!) Preconditions: The ARRC will publish refreshed and very useable loan hardwired fallback language in June.
- Recommendation 2: Third-party technology and operations vendors relevant to business loans (including those with booking, trading, valuation, settlement, and accounting systems used for loans) should complete all necessary enhancements to support SOFR (including but not limited to simple, compounding in arrears, and term SOFR) by September 30, 2020. Rationale: Counterparties must be confident that SOFR can be operationalized by LIBOR cessation as they begin using hardwired fallbacks. Preconditions: The ARRC Business Loans Working Group (BLWG) has been working with vendors and lenders develop conventions and calculations to support systems work. The Business Loan Conventions are scheduled to be released in July.
- Recommendation 3: No business loans using USD LIBOR and maturing after 2021 should be originated after June 30, 2021. Rationale: June 30, 2021 is just six months before the potential end of LIBOR. At that point, it seems inadvisable to add still more loans to the backlog that must soon convert from LIBOR. Preconditions: The LSTA is drafting SOFR “Concept Credit Agreements” to facilitate the origination of SOFR loans. In addition, the development of SOFR-compatible loan systems by 3Q20 (Recommendation 2) will facilitate the executability of SOFR loans.
- Recommendation 4: For business loans specifying that one or more parties will select a replacement rate for USD LIBOR at their discretion, the determining parties should disclose to relevant parties the replacement rate and any related spread adjustment methodology they anticipate selecting at least 6 months prior to the date that a replacement rate would become effective. Rationale: Lenders will need to prepare to transition their loan portfolio and uncertainty around the replacement rate could impact secondary market value of loans. This recommendation is applicable to the amendment fallback approach, which has discretion, not the hardwired fallback.
Ultimately, the ARRC’s Best Practices Recommendations should help prepare markets, including loans, to shift to a post-LIBOR world. By using these sequenced and rational steps, we should reduce the risk around LIBOR transition.