November 4, 2020 - There were two big LIBOR headlines on Monday this week. First, the WSJ reported that trader Tom Hayes, who was convicted of rigging LIBOR, is set to be released from prison in January. Second, the LSTA released its LIBOR Replacement Provisions for Amendment of CLO Indenture. The goal of this document is to help practitioners amend earlier vintage CLOs – often done prior to 2018 – that have no or insufficient LIBOR fallback language. We discuss all – in English! – below.
In July 2017, we learned that LIBOR was likely to end for cash products, probably around year-end 2021. By early 2018, most CLOs were including some form of “Amendment LIBOR Fallback language” that charted a path from LIBOR to a replacement rate. However, CLOs issued prior to 2018 often did not include any fallback language. Instead, those earlier CLOs typically would reference “last quoted LIBOR”, which would have the effect of flipping a floating rate instrument into a fixed rate instrument at the last quoted LIBOR. This is not what investors anticipated when buying these notes.
There are three ways to resolve this conundrum and incorporate workable LIBOR fallback language. First, through New York State or Federal legislation, both of which are in discussion, but neither of which are guaranteed. Second, through refinancing or resetting the outstanding pre-2018 CLOs. Third, through amending the pre-2018 CLOs.
While amending existing CLOs may be logistically challenging, having a “market standard” form of amendment may facilitate the process by providing consistent language. And so, several members asked the LSTA to develop a Form of LIBOR Replacement Provisions for the Amendment of CLO Indentures. We worked with the LSTA CLO Committee to develop this form; it went live on Monday and is available to members here.
In practical terms, the CLO Amendment introduces the key provisions for an amendment to add hardwired fallback language into CLOs that have inadequate fallback language. The provisions reflect the most current language being used in CLO hardwired fallbacks today. First, the language identifies the typical “triggers” that initiate the transition from LIBOR to a replacement rate: i) the administrator announcing that it has ceased or will cease LIBOR publication; ii) the administrator’s regulator saying that the administrator has or will cease LIBOR publication; iii) the regulator’s public statement that LIBOR is no longer representative; or iv) 50% of the assets having transitioned to a replacement rate.
Second, the LSTA form includes a hardwired waterfall of replacement rates: i) Term SOFR plus spread adjustment; ii) Simple or Compounded SOFR plus spread adjustment (Simple and Compounded are bracketed as there is not one single market norm today); iii) the rate selected by the Relevant Governmental Body plus spread adjustment; iv) the rate selected by the Designated Transaction Representative plus spread adjustment; and v) the Fallback Rate (the rate used by the largest percentage of the assets). The language also includes the option to reflect the benchmark rate being used by 50% or the assets or in 50% of new CLOs, as well as a “climb the waterfall” option to move up to Term SOFR or Simple/Compounded SOFR if those rates do not exist at LIBOR transition but subsequently become available.
Again, the goal of this language is to provide a template to help facilitate amendments to add LIBOR fallback language into CLO indentures that do not already include them. However, the work of getting the amendment done still falls to the individual counterparties. We hope that the standard language is one small effort that helps smooth the LIBOR transition process.