December 1, 2020 - As recently reported, on Monday the FCA, the IBA and US banking regulators made a number of announcements relevant to LIBOR transition which were (quite serendipitously!) highlighted in the LSTA’s deep dive into hardwired fallback language webcast later that day. Those statements included inter-agency supervisory guidance which clearly linked the use of hardwired fallback language with banks’ safety and soundness and stated that “new contracts should either utilize a reference rate other than LIBOR or have robust fallback language that includes a clearly defined alternative reference rate after LIBOR’s discontinuation.” On the heels of that guidance from the banking regulators, Christian Fundo (JPM), Jeff Nagle (CWT) and Ian Walker (Covenant Review) made the case for using hardwired fallback language – it represents the most certain, fair and executable approach to fallback language. The speakers also pointed out that most “amendment approach” fallback language requires the borrower and administrative agent to give due consideration to prevailing market convention which is thus likely to follow the hardwired fallback waterfall which is now being adopted in the loan market. In that case, the flexibility of the amendment approach equates to the risk of falling back to Prime at least for some period of time before an amendment is successful. Fortunately, it seems that message is starting to resonate with the loan market. Covenant Review recorded 30% of new and amended institutional loans in October included hardwired fallback language. Even though the benefits of hardwired fallback language are clear, the ARRC hardwired recommendation is complex.
To unpack that complexity, the speakers walked through the key provisions: the triggers (including the early opt-in trigger), the rate and adjustment waterfalls, the agent’s ability to implement conforming changes and various interpretative provisions. (Minutes 12:35-44:40 of the webcast.) In addition, the speakers worked through several scenarios to demonstrate how the hardwired fallback language works in practice, including scenarios highlighting the application of spread adjustments. (Minutes 44:40-57:25 of the webcast.) Those particular scenarios illustrated the ARRC’s recently released FAQs on the ARRC recommended fallback language for business loans which offer further guidance on how the pre-cessation trigger aligns with ISDA’s pre-cessation trigger as well as which spread adjustments would apply in common business loan permutations. In conclusion, while the recent LIBOR announcements may mean that fewer loans will need to execute on their fallback language because there should be more time for the loan market to transition to SOFR organically, the remediation task facing the loan market is still daunting – about 91% of the S&P/LSTA LLI matures after June 2023. Adoption of hardwired fallback language is a key part of that remediation process.