Alerts and Updates
Hardwired for a Smoother LIBOR Transition?
August 6, 2020
Unlike the April 2019 recommendations, the June 2020 recommendations provide only for hardwired fallback provisions and do not include a refreshed amendment approach.
Background on LIBOR Transition and ARRC
The London Interbank Offered Rate (LIBOR), which has served as a reference rate for approximately $350 trillion of debt and derivatives, will be phased out after December 31, 2021. In the United States, the Alternative Reference Rates Committee (ARRC), convened by the Federal Reserve Board and the New York Fed, has been tasked with ensuring a successful transition from USD LIBOR to a more robust reference rate. In June 2017, the ARRC identified the Secured Overnight Financing Rate (SOFR) as its recommended alternative to USD LIBOR. In April 2019, the ARRC first published recommended fallback language for syndicated business loans. At the time, the recommendations provided two approaches: an “amendment approach”―which delays all decisions about the successor rate and adjustment until a future date―and a “hardwired approach”―which hardwires the priority of replacement rates to be selected into the credit agreement upon origination based on what replacement rates are available at the time of replacement and provides for an easier amendment of related terms. While the amendment approach has been adopted widely in the syndicated loan market, the recommendations recognized that the hardwired approach would create a smoother transition away from LIBOR. The hardwired fallback language would offer greater certainty for lenders and borrowers that they will receive or pay a version of SOFR plus a spread adjustment upon a trigger event and, in many cases, eliminate the need for seeking consent for an amendment.
In June 2020, the ARRC released refreshed recommendations regarding fallback language for U.S. dollar-denominated syndicated business loans that reference LIBOR. Unlike the April 2019 recommendations, the June 2020 recommendations provide only for hardwired fallback provisions and do not include a refreshed amendment approach.
What’s New with the Hardwired Approach?
Below is a brief summary of the key changes made in the refreshed “hardwired” language recently released compared to the April 2019 version.
- Benchmark replacement waterfall. The second step of the “benchmark replacement” waterfall is now recommended to be Daily Simple SOFR (as opposed to a compounded SOFR alternative in the April 2019 version), plus adjustment. The first choice in the waterfall continues to be Term SOFR (a forward-looking term rate based on SOFR that does not exist yet), plus adjustment. Market participants may choose to eliminate the first step in the waterfall, or replace the second step with either (i) the sum of Daily Compounded SOFR and adjustment or (ii) the sum of SOFR average and adjustment.
- Unavailability of tenor of benchmark. The refreshed recommendations contemplate a new precessation trigger based on the unavailability of all tenors of LIBOR in addition to permanent cessation triggers such as the actual cessation of LIBOR or its expected cessation (by the administrator of LIBOR, the regulatory supervisor of the administrator of LIBOR, the central bank for the currency of LIBOR or a bankruptcy/resolution official or court with jurisdiction over the administrator of LIBOR). The new precessation trigger accommodates market participants’ preference for a trigger based on the announcement of nonrepresentativeness rather than the cession of LIBOR alone. In particular, the administrative agent’s ability to “turn off” available tenors for which Term SOFR is not available has been broadened to apply to a tenor of a benchmark that has been declared to be nonrepresentative. This change gives more flexibility to the administrative agent to maintain consistency across the selected rates at any point in time in order to optimize outcomes for borrowers and lenders.
- Early opt in. The “early opt-in” feature allows parties to trigger a fallback from LIBOR even if LIBOR is still published and none of the other enumerated triggers have occurred. Whereas the April 2019 version already included the “early opt-in” concept, the June 2020 language has expanded it. Now the “early opt-in” trigger can be initiated by (i) a notification by the administrative agent (or a request by the borrower for the administrative agent to notify) that the number of USD syndicated loans referencing a SOFR-based benchmark reaches a certain threshold agreed by parties, and (ii) a joint election by the borrower and the administrative agent, subject to a negative consent right of lenders.
What About the Amendment Approach?
The ARRC recommends that market participants in the LIBOR-based syndicated loan market start using hardwired fallback language no later than September 30, 2020. On the one hand, the hardwired approach would not create a challenge for market participants to amend thousands of recently originated loans simultaneously when LIBOR is phased out, whereas the amendment approach likely would do so. On the other hand, parties will not be able to leverage the then-existing market conditions to capture more economic value. The hardwired approach will speed up the transition and reduce potential risk of gamesmanship.
There remains uncertainty about applying the hardwired approach in the loan market. While the ARRC recently released conventions related to using SOFR in arrears for syndicated loans on July 22, 2020, not all conventions for a hardwired approach have been finalized. The updated recommendations only reflect a proposed template. Market participants should, with advice from counsel, make appropriate adjustments to the proposed terms when updating their agreements.
About Duane Morris
As the end of LIBOR draws closer, Duane Morris’ LIBOR Transition Team will continue to monitor developments and issue additional Alerts.
For More Information
If you have any questions about this Alert, please contact Roger S. Chari, Joel N. Ephross, Amelia (Amy) H. Huskins, Phuong (Michelle) Ngo, Han Wang, any of the attorneys in our Banking and Finance Group or the attorney in the firm with whom you are regularly in contact.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.