Despite the disruptive events of the pandemic, LIBOR transition continues unabated. Clare Dawson, Chief Executive, Loan Market Association, writes exclusively for TMI about the most recent developments, and what happens next for treasurers.
Despite the challenges, for corporates as well as banks, of dealing with the disruption caused by Covid-19, regulators across the world continue to stress the importance of transitioning away from LIBOR. To that end, milestones have been set in various LIBOR currency jurisdictions relating to the offering of new non-LIBOR products, and the cessation of LIBOR-based lending.
With this pressure on market participants to transition away from LIBOR, what progress has been made recently?
In the European market in particular, a number of large corporates have already entered into loan facilities that contemplate a switch to risk free rates (RFRs) at a given point before end 2021, or, more recently, use RFRs from the outset. However, the loan market has certainly not seen – and needs to gear up for – transitioning on a large scale.
Probably the most important development has been the recent announcement in some jurisdictions of conventions for ‘compounded in arrears’. In Europe in particular, there is a widespread acceptance that compounded in arrears will be the main method of using RFRs for syndicated loans, although for some borrowers and products alternatives such as a forward-looking RFR-based term rate, a fixed rate or a central bank rate may be more appropriate.
There are a number of aspects of compounded RFRs for the loan market that have broad consensus across different currency jurisdictions. These include the use of a lookback period when calculating interest, in recognition of the fact that loan market participants need sufficient time for notification and collection of payments; the treatment of non-business days; the business day convention of modified following business day; the operation of distribution of interest; payment of interest when there are prepayments; and the treatment of the margin – that is, the margin itself is not compounded.
In certain areas of detail however, the various currency group recommendations vary to some extent. Nevertheless, they are a good starting point from which market participants can work, and are intended to be flexible and non-prescriptive. The challenge for the market, of course, where there are differences in the conventions proposed by different currency groups, is how to deal with multi-currency facilities – a common feature of the syndicated loan market.
The development of conventions for compounding is key for the adaptation of both treasury and bank systems, as well as production of documentation for RFR-based loans – an aspect of transitioning in which the Loan Market Association (LMA) has, of course, been doing a great deal of work. Therefore, progress on conventions has enabled the market to work quickly to develop the tools needed for widespread adoption of RFR-based loans.
In terms of transition of existing LIBOR-based facilities, another key development has been the issuing of recommendations by various currency groups on how to calculate the spread adjustment to account for the difference between LIBOR and RFR-based rates. This gives the market more clarity on how loans will transition on a cessation or pre-cessation trigger for LIBOR, but the market still has to determine a direction for active transitioning of loans, though market precedents may be helpful in this respect.
An issue of concern to many in the loan market is the status of RFR-based forward-looking term rates. These are currently not available for use, and are not expected to be so until the end of this year for sterling, and the middle of next year for some other currencies. Use cases have been explicitly stated to be limited by the Sterling Risk-Free Reference Rates Working Group, and may well be by other currency groups, though there is acceptance that for certain products, such as some trade finance and export credit agency (ECA) finance, they are likely to be very important.
The question therefore remains: what do corporate treasurers and others in charge of funding operations need to be doing to ensure their own transition from LIBOR to RFRs is an orderly process? Having identified all their contracts in which LIBOR plays a role, and the maturity of those contracts, there are some key next steps on which to focus.
In summary, there is still a lot of work to do, but there is plenty of useful information available to educate and support market participants. Good communication between corporates and their banks and other counterparties, as well as a thorough understanding of the issues, are key to finding the right solutions.