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Tim Rennie, partner at Ashurst LLP, with supporting contributions from Nick Moore, Darren Phelan and Briony Holcombe of Ashurst LLP consider the impact of the Loan Market Association (LMA) list of loans referencing risk-free rates.
The LMA’s list of RFR transactions and, in one case, the publication of the facility agreement itself, is based on publicly available information. It is helpful to have a tracker of market activity, but the stark position to note is that there remains only a handful of transactions adopting RFRs since the first Sterling Overnight Index Average (SONIA) loan was publicised in July 2019 (which we acted on). With only 12 deals across the four relevant currencies, with two of these originated on the Inter-bank Offered Rate (IBOR) with a built-in rate switch mechanism, it is a short list.
The reality is that most lenders are working through the myriad of issues with adopting RFRs, including operational, legal implementation, communications with clients, etc. Banks have received clear messages from the Financial Conduct Authority (FCA) regarding the adoption of RFRs in the loan market, and it is the cessation of the London Inter-bank Offered Rate (LIBOR) as a guaranteed rate from 31 December 2021 alongside these communications from their regulator that is driving the change, not the LMA list.
The publication of the BAT facility agreement on the LMA website, which has the built-in rate switch mechanics, will be useful for many market participants to gain a better understanding of the issues they may face in adopting a RFR in their loan documentation and will help them determine their own house position on a number of the variable positions that arise in adopting a RFR in a loan agreement.
Some of the main obstacles to highlight are as follows:
lenders’ operating systems need updating to accommodate RFR lending—the existing RFR facilities have been implemented with some level of manual calculations to date
there is currently no primary screen rate to determine the RFR for a specified interest period and solutions need to be found across currencies
there is no market consensus on fallback arrangements if the documented screen rate is unavailable
the calculation methodology is not yet settled. While the observation period shift is currently considered by many lenders as the expected calculation method, it is not the methodology used in a number of the RFR loans on the LMA list, and there remains some uncertainty around its use, what the rounding convention should be and how many business days should apply in the lag period
how to calculate the adjustment spread for specific interest periods between the current IBOR rate and the new RFR and whether this is a separate element of the interest rate or built into the margin
All of these points are being worked on by third party providers or specialist teams set up within lenders alongside their legal advisers, and lenders typically expect to have addressed most of those within their control by Q3 2020 and once internal systems integration occurs, upscaling of RFR loan origination should occur on a more regular basis.
The secondary trading market is one area in which there has not been significant market development or commentary and we expect this to only become a focus once larger syndicated deals are entered into where the lenders do not expect to hold their commitments to maturity. To a large extent, the solution here will be dictated by secondary market participants.
A final point worth mentioning is that certain parts of the market, such as Islamic financing and export financing, are not suitable for the compounded RFR and a term rate solution is required, which is not yet available.
The Bank of England Sterling RFR working groups are expected to finalise their findings shortly and we expect the fallback arrangements, adjustment spreads and calculation methodology to be settled in the near future.
The International Swaps and Derivatives Association (ISDA) has already undertaken similar exercises with its consultations and, where the RFR working group consultations recommend the adoption of the same position as ISDA has adopted, we anticipate that the loan market will swiftly accept those recommendations. This will then enable the operating systems to be conformed to these calculation methodologies etc and be built into lenders’ systems to automate the RFR calculations.
The above assumes similar approaches are adopted across all RFRs. If one market, say the English market for SONIA, adopts one approach and the US market for Secured Overnight Financing Rates adopts a different approach, we do not consider that to be sustainable in the long term and would predict a coalescing in due course around one consensus approach to the calculations.
This is a question best answered with hindsight! Right now, the RFR taskforce teams within banks are returning their focus to the RFR transition and adoption project following most of these teams having spent the last couple of months assisting with liquidity loans, government funding schemes etc.
These teams are working to address the issues identified above in the near term and are fully aware of the FCA’s revised timetable for no new sterling LIBOR loan market issuance from the end of Q1 2021.
RFR transition remains front of mind for the banks, however it is not as high up the agenda for all market participants (such as some credit funds), and therefore transitioning all parts of the loan market to RFRs remains a challenge.
Tim Rennie, Nick Moore and Jess Jenner, all partners at Ashurst LLP, along with Darren Phelan, a senior associate at Ashurst LLP, acted on the first five SONIA loans in the market, each of which is included in the LMA list.
Interviewed by Gloria Palazzi
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Miranda is a solicitor specialising in leveraged and acquisition finance. She trained at Hogan Lovells International LLP and qualified into the international banking and finance team. During her time at Hogan Lovells she worked on a variety of domestic and cross-border transactions, acting for both borrowers and lenders. She also experienced secondments to Barclays Bank PLC and Kaupthing Bank hf.
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