September 13, 2018 - The U.S. Alternative Reference Rates Committee (ARRC) is planning to release a market consultation on LIBOR fallbacks for syndicated loans soon. As Co-Chair of the ARRC Business Loans and CLO Committee, the LSTA is hoping that the consultation is the first step in developing quasi-standardized LIBOR fallback language for loans. We also are hoping that, by responding to the consultation, you will help us help you in this important step!
So what can you expect in this consultation? As explained at the Thomson Reuters LPC Annual Conference on Wednesday and discussed at the ARRC Roundtable in July, there are two potential approaches to fallback language for loans: i) the amendment approach and ii) the hardwired approach. (See Slide 7 in this presentation.)
The amendment approach uses loans’ flexibility to provide a streamlined amendment mechanism for negotiating a replacement benchmark. It is similar to the “LIBOR replacement” language that has developed in the syndicated loan market in the past year, but offers additional specificity with respect to potential replacement benchmark rates, replacement benchmark spreads and lender votes. On the positive side, it maximizes flexibility and it also does not rely on a rate (such as term SOFR) and spread adjustment methodology that does not yet exist. However, there are downsides as well: it may not be feasible to use the amendment approach if thousands of loans must be amended simultaneously due to LIBOR cessation. Additionally, the amendment approach may create the opportunity for different market participants to game the outcome in in different market environments.
In contrast, the hardwired approach “hardwires” all decision making at the inception of a credit agreement. The trigger events, fallback rate and replacement benchmark spread are all defined upfront, creating clarity of outcome in the event of LIBOR cessation. On the positive side, because the hardwired approach does not rely on amendments, it should be possible to transition thousands of loans simultaneously. Additionally, because terms are agreed upfront, there should be limited ability for participants to game the outcome. However, the hardwired approach relies on components which do not currently exist. That said, in the event that certain components do not exist, the hardwired approach falls back to an amendment approach.
In addition to the consultation, we will be discussing LIBOR cessation, transition and next steps for loans at the LSTA Annual Conference on October 24, 2018 with Sandie O’Connor (the ARRC Chairwoman and sixth most powerful woman in banking!).