It is by no means hyperbolic to describe this as the most significant upheaval in debt markets since the financial crisis, and probably also in the living memory of even the most gnarled of market observers.
A detailed history lesson on the drivers for this fundamental change is beyond the scope of this briefing note, but a thorough exposition of LIBOR's many travails since the credit crunch, and a "j'accuse" directed towards those individuals and institutions found to be at fault, can be accessed here: Guardian Article re LIBOR Scandal.
Since the beginning of 2021, the transition process has commenced in earnest. There have been a number of catalysts for this, including the following:
- In March, the FCA announced that all LIBOR settings for GBP, EUR, CHF and JPY (for all tenors), and USD (in respect of the 1-week and 2-month tenors), will cease from 31 December 2021, with the remaining USD maturities ceasing from 30 June 2023. See: FCA Announcement re LIBOR Discontinuations
- The regulatory deadline of 31 March 2021 to cease writing new debt products referencing LIBOR came and went. See: Bank of England Roadmap
- The Loan Market Association finalised its "exposure drafts" of compounded RFR and rate-switching facility agreements creating market standard "recommended forms" for such purposes. See: LMA Member Alert
What this means is that any loan facility which you are either originating or borrowing may not use LIBOR as a benchmark and this has been the case since 31 March. Equally, if you are party to an existing loan facility (whether as lender or borrower) which references LIBOR for interest rate setting, then you will have to transition that facility away from LIBOR before the end of the year. This is likely to involve either a refinancing or a substantive degree of amendment to existing documentation, either of which approaches will necessitate a process requiring legal advice.
Happily, there are fall-back reference rates which can be used for the various discontinued currencies. For GBP, the main replacement rate is known as "compounded SONIA". SONIA is the "Sterling Overnight Index Average", which is an overnight deposit rate at which prime banks may hold overnight deposits from other prime banks in the London interbank market. It is set at 9am on the business day following the business day on which the overnight deposit was placed. It is therefore a look-back rate (whereas LIBOR is a forward-looking term rate). Accordingly, in order to operate effectively within the context of current loan market conventions under which commercial loans are split into forward-looking interest periods (typically of 1, 3 or 6 months), SONIA has to be compounded on a look back basis with regard to SONIA on the day occurring five business days prior to each day occurring during an interest period.
Whilst there is a forward-looking term rate for SONIA for 1, 3, 6 and 12 month tenors (see: Refinitive Term SONIA Rate), regulators have stipulated that, because this rate is theoretically susceptible to manipulation in the same way that LIBOR is, market-participants should not use it, and should use compounded SONIA instead.
None of this is straightforward or easy to navigate. Luckily, you can rely on our Banking & Finance team here at Morton Fraser to guide you through the intricacies of this seismic shift in debt markets from a practical, legal and regulatory perspective. Don't hesitate to contact us should you need our assistance with this.
Ross Caldwell: Ross.Caldwell@morton-fraser.com - 0131 247 1149
Bev Wood: Beverley.Wood@morton-fraser.com - 0131 247 1324
John Lunn: John.Lunn@morton-fraser.com - 0131 247 1066
Andrew Meakin: Andrew.Meakin@morton-fraser.com - 0131 247 1253
