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AML & Financial Services Regulatory

Europe: LIBOR – Redefining the transition timeline

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In brief

Progress on the reform of LIBOR has not stopped during the COVID-19 pandemic.

While the overall timing for LIBOR transition has remained unchanged, the Working Group on Sterling Risk-Free Reference Rates (RFRWG) has recognized the need to introduce some flexibility in relation to the interim transition deadlines to ensure that lenders are able to continue to supply credit to the real economy and assist with economic recovery.

Although market participants will undoubtedly welcome this added flexibility, a smooth and timely transition will still require lenders to be proactive in reviewing and implementing their LIBOR transition plans.

On 29 April 2020, the RFRWG issued a statement on the impact of Coronavirus on the timeline for firms’ LIBOR transition plans (“Statement”).1 Although the key message conveyed by the Statement (itself referring to a joint statement of the FCA, the Bank of England and the RFRWG dated 25 March 20202) is that the overall timing for discontinuation of LIBOR will be maintained, interim deadlines have been adjusted to respond to the challenges posed by the COVID-19 pandemic.

While the bond market has already witnessed considerable progress in transitioning to SONIA, the pace of transition in the loan market has been considerably slower, and the RFRWG, the FCA and the Bank of England have recognized that, under the current circumstances, it may not be feasible to complete the transition away from LIBOR on all new sterling LIBOR-linked loans within the original time frame (i.e., by Q3 2020). The adjustment of the interim timelines will prompt lenders to rethink their transition plans and redefine their strategy.

What are lenders required to do and by when?

The table below sets out the new timeline and the actions required from lenders:

Date What needs to happen Actions that lenders need to take
By Q3 2020 New non-LIBOR linked products to be made available to customers Establish, approve and implement the use of new non-LIBOR linked products
By Q4 2020 Clear contractual arrangements to be included in all new and re-financed LIBOR-referencing loan products to facilitate conversion (pre-agreed conversion terms or an agreed process for renegotiation to SONIA or other alternatives) Introduce conversion or fallback mechanisms in new LIBOR-referencing loan contracts (whether “new money” deals or refinancings)
By Q1 2021 No further issuance of sterling LIBORreferencing loan products expiring after Q4 2021 LIBOR-linked products to be discontinued

New non-LIBOR linked products to be used for any facilities expiring after Q4 2021 (or which can possibly be extended or renewed in the same terms)
By Q4 2021 Discontinuation of LIBOR Implement changes to all legacy deals to ensure that LIBOR will no longer be used

 

Although most market participants will certainly welcome an alleviation of the interim transition deadlines, the six-month delay in the discontinuation of new LIBOR products may result in a number of LIBOR-linked contracts continuing to be originated up to Q1 2021. Whilst we have seen most lenders including conversion or fallback mechanisms in their new LIBOR-linked contracts for some time now, any contracts in which such fallback mechanisms are not contemplated will require remediation within a very short time frame.

Furthermore, the practical difficulties caused by the limited period available to re-paper legacy deals (which will often need to be amended on a contract by contract basis and/or require involved negotiations between parties) will not be addressed and will even be exacerbated by the uncertainty relating to the approach to legacy contracts (including in relation to the calculation of the credit spread adjustment in cash products) and by lenders’ inability to cope with multiple competing priorities during this exceptionally demanding period.

What are the next steps for lenders?

To address the issues identified above, lenders should:

  • carefully consider whether new LIBOR-linked origination is actually required or if alternative products that are nonLIBOR-linked may be offered to customers;
  • introduce robust conversion and/or fallback mechanisms in new loan or refinancing documentation (to the extent that this has not yet been implemented as standard practice);
  • identify all legacy LIBOR-linked contracts and proactively initiate discussions with borrowers to enable transition to alternative rates;
  • continue to monitor the progress of the work of the RFRWG, that will continue to deliver the transition plan and address pending issues, including approach to ‘tough legacy’ contracts and calculation methodology for a fair credit spread adjustment in legacy cash products; and
  • engage with the PRA and FCA, who recently announced their decision to end the suspension of transition data reporting and of certain supervisory activities due to COVID-19 and resume supervisory engagement with firms on their LIBOR transition progress from 1 June 2020.
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Author

Sarah Porter is a partner in Baker McKenzie’s Structured Finance Group in London.

Author

Phung Pham is of counsel in Baker McKenzie's Structured Capital Markets Practice, focusing on Derivatives. He has spent the majority of his career in private practice, and has also previously worked in-house at a leading US investment bank. Phung has extensive cross-border transactional experience, particularly in emerging markets, and has practised in London, Moscow, New York and Melbourne.

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Joana Maria Fragata is a Knowledge Lawyer in Baker McKenzie London office.

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