With most firms having now dealt with the challenges that 2018 and 2019 presented, the transition away from LIBOR and, generally, InterBank Offered Rates (IBORs) is one of key issues now facing financial markets participants.

In July 2018, the FCA’s Chief Executive stressed that market participants need to “start moving away from LIBOR in new contracts” and to “look for ways of reducing exposure to LIBOR in legacy contracts, where practicable.”

Considerable progress was made in 2018 and in the first half of 2019 with the Bank of England, the US Federal Reserve and certain trade associations such as ISDA and the LMA leading the charge in helping market participants coordinate. In addition, the market started from 2018 to prepare for the demand in liquidity in alternative reference rates with, for example, ICE, CME and Curve launching 1m or 3m SONIA contracts, CME launching a 3m SOFR contract and Eurex launching a 3m SARON contract.

The number of contracts referencing IBORs remains significant. According to ISDA, the notional of interest rate derivatives referring IBORs in 2018 represented approximately two thirds of the total notional traded with many of those contracts maturing post 2021 (the date LIBOR is expected to cease to be supported).

While the market continues to develop replacement rates, market participants are left to review high volumes of complex legacy trades to identify rates and contractually agreed fallbacks. Once identified, as with many regulatory challenges of recent years, a time-consuming client outreach is required to make changes to the documentation. Most FS lawyers will have encountered rates fallbacks, which are either set out in the contracts or, for derivatives, in the 2006 ISDA Definitions. However, these fallbacks do not tend to be designed for a permanent discontinuation of a benchmark rate.

For Derivatives, the 2006 ISDA Definitions include fallbacks and new definitions in the 2019 ISDA Interest Rate Definitions. As per previous ISDA documentation changes, the new definitions will apply to new trades and market participants will be able to elect to adhere to an ISDA protocol to amend legacy trade populations referencing the 2006 ISDA Definitions entered into with another adhering party.

For the European syndicated loan market, the Loan Market Association (LMA) has published an optional “replacement of screen rate” clause but as it optional it may not be in all recent loans and because it requires the consent of the majority of lenders to be effective, it will be operationally burdensome and time consuming in practice to implement due to having to coordinate lenders and borrowers for each loan.

For the Bond market, a number of bond issuers started to issue bonds referencing alternative reference rates such as SONIA or SOFR from the end of 2018. Almost all other bond issuances will include fallback provisions which, as for derivatives contracts, where not designed for a permanent discontinuation of a benchmark rate. Changing the benchmark rate is even more difficult than for derivatives or loans as the consent of a majority (or in some cases all) noteholders will be required. Effecting such a change will involve liaising with the Trustee to attempt to agree in advance amendment documentation to be sent to noteholders through the clearing systems for them to consent with the obvious limitations that this approach entails being (i) Trustees will be incredibly busy assisting thousands of issuers with the very same exercise and (ii) it will not be possible to chase or force noteholders to respond as the issuer will not typically be able to ascertain their identity.

What next?

2019 and 2020 will be a very busy year for those in legal departments involved in the IBOR transition including continuing to participate in industry working groups discussions, liaising with other internal stakeholders (risk, sales, compliance, back and middle office, tax etc), identifying different contracts, product types and actions, agreeing the client outreach strategy for each such contract and product type and, crucially, completing that client outreach. We’ve placed a number of consultant lawyers to assist with some of the recent regulatory change projects undertaken by our clients. Please contact us.