In the US, on 30 June 2020, the New York Federal Reserve’s Alternative Reference Rates Committee (ARRC) published its ‘updated recommended hardwired fall-back language for syndicated loans’, denominated in US dollar.
On 27 August 2020, the ARRC published its updated ‘recommended hardwired fall-back language for bilateral business loans’. These recommendations are very similar to those for syndicated loans, but they include a so-called ‘hedged loan approach’ which allows for alignment with the ISDA fall-back.
In May of this year, the ARRC published its ‘recommended best practices for completing the transition from LIBOR’. Now that the hard-wired language has been published, its use is expected in new bilateral and syndicated loan facilities in the US market.
On July 22 2020, the ARRC released conventions related to using the Secured Overnight Financing Rate (SOFR) in arrears, in syndicated loans.
In the UK, on 25 March 2020, the Working Group on Sterling Risk-Free Reference Rates (RFR WG) recommended :
- By the end of Q3 2020 lenders should be in a position to offer non-LIBOR linked products to their customers;
- After the end of Q3 2020 lenders, working with their borrowers, should include clear contractual arrangements in all new and re-financed LIBOR-referencing loan products to facilitate conversion ahead of end-2021, through pre-agreed conversion terms or an agreed process for renegotiation, to Sterling Overnight Index Average (SONIA) or other alternatives; and
- All new issuance of sterling LIBOR-referencing loan products that expire after the end of 2021 should cease by the end of Q1 2021.
The principal lending system providers are expected to have developed their platforms to meet these milestones. The RFR WG recognises that not all market participants may have implemented and tested their platform by the end of Q3 however, so would expect to see product scale increasing over time.
In July 2020, the RFR WG published a set of questions and answers aimed at clarifying the interpretation of this recommendation and other elements relating to the statement.
In order to aid the adoption of such ‘clear contractual arrangements…to facilitate conversion’ the Loan Markets Association (LMA) published ‘a note on the revised replacement of screen rate clause’ in August 2020. Shortly after, the RFR WG published ‘recommendations on conventions for referencing compounded in arrears SONIA in the sterling loan market’. In September, the LMA published an ‘exposure draft of multicurrency term and revolving facilities agreement incorporating rate switch provisions’. This exposure draft referenced the LMA’s recommendations on interest rate conventions. It facilitates a change in reference rates from an initial term rate such as LIBOR directly to a compounded RFR, in accordance with the second of the aforementioned recommendations.
The RFR WG also published a paper on ‘active transition of GBP LIBOR referencing loans’. This paper can be used by all wholesale loan market participants to initiate discussions about actively amending GBP LIBOR referencing loans to reference SONIA or another appropriate alternative reference rate.
In addition, the RFR WG published a recommendation of credit spread methodology in cash products referencing GBP LIBOR.
That methodology is the same as the ISDA fall-back methodology. The ARRC had similarly published recommendations for ‘hardwired fall-back language’ for both syndicated and for bilateral loans. While these recommendations are in many ways similar to those of ISDA, a notable difference is that they include a suggested waterfall of fall-back rates and adjustment spreads.
The methodologies described are intended to ensure that contracts referencing LIBOR will continue to function as closely as possible to the original agreement, in the event they start referencing an RFR.
Because LIBORs incorporate credit risk and RFRs do not, LIBOR rates are typically higher than (compounded) RFR rates. The credit spread calculated using a respective methodology is then, simply put, added to the applicable (compounded) RFR rate to adjust for the difference.