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LIBOR Transition Update

  • United Kingdom
  • Energy and infrastructure - Clean energy

29-05-2020

LIBOR

The London Interbank Offered Rate (LIBOR) is one of the Interbank Offered Rates (IBORs) widely used in global finance markets. LIBOR is calculated and published daily across Sterling, US dollars, Euro, Yen and Swiss francs for overnight, one week and 1, 2, 3, 6 and 12 months. It is the average rate at which banks lend to each other on an unsecured basis in the London interbank market for the specified currency and period. In many finance arrangements, the interest rate is the sum of LIBOR and the Margin. LIBOR is also used as a reference or benchmark interest rate in many other contracts.

SONIA

In April 2017, the Bank of England Working Group on Sterling Risk-Free Reference Rates (the Working Group) identified the Sterling Overnight Index Average (SONIA) as the preferred alternative to LIBOR.

Whereas LIBOR is forward-looking over a specified period, SONIA is a backward-looking overnight interest rate. Whereas LIBOR reflects information submitted by banks, SONIA reflects actual transactions in overnight indexed swaps for unsecured transactions in the sterling market. Accordingly, by not including an element of bank credit risk, it is described as a risk-free rate.

Non-Sterling LIBORs will be replaced by different risk-free rates (for example, the Secured Overnight Financing Rate for US dollar LIBOR). Some currencies are retaining an IBOR (for example EURIBOR is being reformed rather than replaced). Other options remain such as using a fixed interest rate or using the Bank of England base rate.

New target dates

In late April 2020, and notwithstanding continued progress in the transition with three landmark transactions featuring SONIA (including the first syndicated loan), it was recognised that the transition in loan markets would not be as speedy as originally intended. As a result, the Working Group recommended the following new targets:

  • by the end of Q3 2020, lenders should offer non-LIBOR linked products to their customers;
  • after the end of Q3 2020, lenders and borrowers should include a mechanism in new and re-financed LIBOR-referencing loans to facilitate conversion by the end of 2021, using pre-agreed conversion terms or an agreed process for renegotiation, to 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.

Although some commentators recommend delaying the transition further in the current environment or even scrapping it altogether, the transition to SONIA in the bond market has been largely completed and our expectation is that it will continue to be important to pro-actively address the same transition loan transactions in Clean Energy.

Ongoing discussion

The legal and commercial position is fluid and there is a lot to consider. Key discussion topics include:

  • Lenders and borrowers taking stock of legacy LIBOR transactions which mature after the end of 2021. It may be necessary to amend these to accommodate the transition. Similarly, it may be necessary to modify interest fallback provisions in existing Finance Documents.
  • The loan market is being encourage to adopt SONIA compounded in arrears which cannot be calculated at the start of the interest period. A proposed solution is that interest rate is calculated before the end of the interest period. This results in a time lag between the interest period and interest reference period.
  • In parallel, Term SONIA is being developed. This is a forward-looking term reference rate based on overnight SONIA which is currently in development and might be available in Q4 2020 and which has the potential to be a more straightforward replacement than compound SONIA.

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