January 14, 2019 - Over the course of 2018, the transition away from LIBOR has dominated the thoughts of many financial market participants – a fact that is unlikely to change in 2019. Lenders have been working hard to develop more standard LIBOR fallback language across all business loans. In September 2018, the Alternative Reference Rates Committee (ARRC) released a syndicated loan LIBOR fallback consultation (and posted responses in December). Then, in December, the ARRC released a LIBOR fallback consultation on bilateral business loans and on January 7th, the ARRC (via the American Bankers Association, co-chair of the ARRC’s Business Loans Working Group) released a webcast and slides explaining the bilateral loans consultation. While there is considerable overlap between the two loans consultations, there are areas of difference of which market participants should be aware.
To level set, we remind readers of the key components of fallback language (and gently recommend the following links explaining i) syndicated loan triggers, ii) the syndicated loan amendment approach and ii) the syndicated loan hardwired approach.) We then highlight the differences between the syndicated loans and bilateral loans consultations.
LIBOR fallback language answers the question “If LIBOR disappears, to what rate does my loan fall back?” It comprises three main components:
- The trigger. This is the event that precipitates a transition from LIBOR to a new reference rate.
- The benchmark replacement process/waterfall. This is the process by which the rate that replaces LIBOR is determined.
- The replacement benchmark spread adjustment. Because SOFR (the likely replacement rate) is expected to be lower than LIBOR, there likely will need to be a one-time spread adjustment to make the rates more comparable.
Like the syndicated loans consultation, the bilateral loans consultation provides for an amendment approach and a hardwired approach to fallback language. The Amendment approach would provide a streamlined amendment mechanism that provides flexibility in negotiating a replacement benchmark and spread adjustment. The Hardwired approach would offer a clear, predetermined waterfall for selecting a replacement benchmark and spread adjustment that would apply if LIBOR is no longer usable. While the architecture of the two proposals is similar across the consultations, there are certain differences reflecting the differences in the two products. These include:
- Where the syndicated loans consultation makes numerous references to actions by “administrative agent” and “Required Lenders,” these parties and concepts are not found in the bilateral loans consultation.
- The drafting of the “amendment approach” set forth in the syndicated loans consultation permits the borrower to trigger a “Benchmark Transition Determination” (i.e. a mandatory trigger event or the opt-in trigger). In the bilateral loans consultation, only the Lender can trigger a Benchmark Transition Determination.
- With respect to the “hardwired approach”, the bilateral loans consultation offers a different mechanism for determination of the “Replacement Benchmark” if neither of the two alternative versions of SOFR (term or compounded) is available as of any interest reset date after a transition from LIBOR. (Overnight SOFR is not offered as the third fallback in the waterfall as it is in the syndicated loans consultation.) The language provides that the “lender will select, in its sole discretion, an alternate rate of interest as the Benchmark [giving due consideration to any rate and spread adjustment reflecting any evolving or then existing convention for similar U.S. dollar denominated credit facilities, which may include any spread adjustment that is selected, endorsed or recommended as the replacement for such Benchmark by the [ARRC or Fed]]…” and then offers the bracketed option of negative consent by the borrower: “[, which becomes effective unless the Borrower delivers to the Lender, within [five][ten] Business Days of receipt of notice of the Lender’s selection, a written notice to the Lender rejecting such amendment].” By contrast, the syndicated loans consultation proposes that the borrower and the administrative agent agree on a replacement benchmark if none of the SOFR-based alternatives is available. This tension between lender discretion and borrower negative consent found in the replacement rate waterfall also appears in the early opt-in trigger in the bilateral loans consultation. (See “Benchmark Transition Determination” set forth in Appendix II.) In the case of an opt-in trigger, the lender may select Term SOFR without borrower consent or, if the bracketed language is included, lender may select Term SOFR only if borrower has not delivered an objection.
Finally, the most important difference is that the bilateral loans consultation offers a third approach to contract language designed for hedged bilateral loans and seeks comment on the relationship between loans that implement a replacement benchmark and related hedging arrangements. The “hedged loan approach” provides for the full or partially hedged loan to fall back to the rate and spread selected by ISDA for derivatives in the ISDA definitions. This approach may be of interest to market participants who value consistency between the fallbacks for loans and swaps, but it is important that market participants consider other costs and mismatches between loans and related hedges which can result. The bilateral loans consultation offers a useful discussion of some of these considerations (See Part II, Section G on page 14). While this discussion may be of particular interest in the bilateral loan market, it is not necessarily limited in application to bilateral loans.
In conclusion, we remind all market participants that, at a minimum, they should review their existing loan agreements to be aware of the relevant LIBOR fallback provisions contained therein. To those readers who participate in the bilateral loan market, we encourage you to read this consultation and submit feedback on the bilateral loans consultation.