LIBOR: The End of The World As We Know It (And I Feel Fine?)

A few months ago, the head of the UK’s Financial Conduct Authority announced that it will stop requiring the reference banks to submit sterling quotes for LIBOR, the interbank lending rate, by the end of 2021. The acronym refers to the London-based unsecured wholesale market rates for jumbo deposits between major banks that are denominated in certain designated currencies. LIBOR is the most commonly used floating interest rate at which banks lend to each other, and is incorporated in several trillions of dollars of U.S. commercial loan products, including commercial mortgages, guaranties, derivatives, securitized and packaged consumer loans and other credit support documents.

LIBOR has been in the popular press for its scandal-ridden history. Starting with the credit crunch of 2008, it came under scrutiny as an indicator of the financial health of large financial institutions. And, in 2012, regulatory authorities uncovered a widespread LIBOR-fixing scheme, and financial institutions on both sides of the pond came under fire for artificially manipulating LIBOR to their benefit. This led to an overhaul of the way LIBOR is being calculated and administered, most importantly by the transfer of the supervising authority from the British Bankers’ Association to the ICE Benchmark Administration in 2014. However, these governance improvements have been deemed insufficient. As the underlying markets are relatively inactive and not expected to become liquid in the future, questions have been raised about the sustainability of LIBOR, and regulators are now looking for an alternative.

The transition has sparked a lot of debate within the US $4 trillion syndicated loan market which is of particular interest here, and industry bodies, most notably the Loan Syndications and Trading Association, are monitoring this subject closely.

So what are lenders and borrowers in the U.S. energy industry to do to prepare for the potential end of LIBOR?

  • Make sure their loan documents, old and new, contemplate a life without LIBOR. Documents that incorporate LIBOR but lack a mechanism for selecting a replacement when LIBOR is no longer available should be amended if they are expected to stay in place past 2021.

  • Evaluate the existing fallback provisions in legacy syndicated loan documents. The fallback provisions in market standard documents were designed to address specific scenarios of market disruption and have certain limitations. For example, successor provisions won’t prove very useful, as they merely provide for a solution in case another entity takes over the publication of LIBOR, and not a scenario in which LIBOR is phased out or abandoned completely. Interpolation and alternative information source provisions might prove problematic too. Provisions that empower one party to interpolate between other available LIBOR rates if the LIBOR rate of the selected tenor is no longer available will prove futile if the benchmark itself no longer exists. Similarly, provisions that empower one party to select a different source for the screen rate will not be of use if the underlying benchmark is not available anywhere.

  • Monitor the development of alternative reference rate language. In the U.S., certain major banks, regulators, and other relevant market participants have formed a committee (the “Alternate Reference Rates Committee”) to determine the market preferred replacement benchmark rate. Thus far, their focus has been on the derivatives market, where the exposure to LIBOR dwarfs other areas. One potential alternative rate is in the works, but it’s not a good fit for syndicated loans, and the committee’s work is ongoing. Once an appropriate alternative benchmark has been developed, parties can look to amend existing documentation to adapt to the new normal.

  • Adjust voting provisions to improve flexibility to amend. Where possible, lenders and borrowers may look to adjust their credit agreement voting provisions so that any change to the interest rate benchmark will not require a 100% vote. In syndicated loan documentation, borrowers may wish to have the selection of a replacement rate require the approval of a majority of lenders, rather than requiring unanimous approval to expedite the selection of a new rate once a market consensus is reached. Certain lender groups have however expressed concerns that majority lender consent is not appropriate to amend a term as fundamental as pricing.

  • Examine yank-a-bank provisions. Yank-a-bank provisions can potentially prove helpful, as they would permit borrowers to remove any lenders that object to a proposed replacement rate amendment.

  • Negotiate in good faith. It seems that the old principle that parties should negotiate in good faith may prove the most useful practice here. Counsel can look to incorporate provisions to require the borrower and the majority lenders to negotiate in good faith to formulate LIBOR replacement provisions.