While we are waiting on the LMA's Working Sub-Group on Transition Issues in Syndicated Loan Markets to produce draft provisions dealing with the transition to SONIA, their US counterpart, the Alternative Reference Rates Committee (ARRC) has already done so for SOFR, the US dollar risk free rate (RFR), in its recent consultation paper "Regarding More Robust LIBOR Fallback Contract Language for New Originations of LIBOR Syndicated Business Loans".
The ARRC's approach is likely to be influential for the LMA in relation to transitional drafting for USD (and potentially for other currencies as well in the interests of consistency). The highlights of the ARRC consultation paper include:
"Amendment approach" vs "hardwired approach"
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The draft provisions offer a choice between two alternative approaches. The amendment approach is similar to the current LMA replacement rate provision in that it is an agreement that upon the occurrence of a trigger event, the parties will seek to agree a replacement interest rate, for approval by the majority lenders. By contrast, the hardwired approach seeks to mechanically replace the LIBOR rate with an SOFR based rate (including a spread adjustment) if and when a trigger event occurs.
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The disadvantage of the hardwired approach, as the ARRC recognise, is that it seeks to comprehensively regulate for fact situations the details of which are not currently known, given that the formulation of the replacement benchmark spread to reflect credit risk, as well as the derivation of forward looking term rates from a historic overnight RFR is currently work in progress.
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The disadvantage of the amendment approach is that agreement of the replacement rate at the time a trigger event occurs could become a matter of negotiation, and also that given the volume of loans involved, it will not be practical to agree an amendment for each facility in a short timeframe. The ARRC acknowledge that where the amendment approach is used, it is likely that further amendments to the provisions to introduce "hardwiring" may be required in the future. It remains to be seen whether greater certainty can be achieved in relation to the other relevant workstreams before market participants feel it is essential to start including detailed provisions in their documentation.
Benchmark Discontinuance Events
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The draft provisions also offer the user a choice in relation to the content of the trigger event: – should it be actual discontinuance (as per the ISDA approach) or should it include for example a statement by the administrator that LIBOR is no longer reliable? There is also a version in which the trigger event consists of other loans in the market using term SOFR as a reference rate, in which case the "hardwired" replacement is only activated if the required lenders agree.
Other issues
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The paper also mentions certain other issues arising from the transition including the fact that consequential amendments (e.g. to margin protection provisions) will be required, as well as the fact that mismatches with ISDA are likely to arise.
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It also notes that the draft provisions impose new responsibilities on administrative parties, for example, in relation to the determination of "Benchmark Discontinuance Events" which they will need to prepare themselves for.
Given the nature of the changes, it is inevitable that the transition to RFRs will give rise to a considerable number of issues from a legal and documentation perspective. We aim to keep you updated with future developments on this subject issue so stay tuned!
