Trends, Challenges and the Recommended Revised Form of Replacement Screen Rate Clause and Users Guide
There have been prolonged discussions over a much-needed reform to the London Interbank Offered Rate (LIBOR) for quite some time. In 2017, the UK Financial Conduct Authority has announced that it would no longer compel panel banks to make LIBOR submissions after 2021. In 2019, various regulators have also announced their plans in relation to LIBOR transition. According to more recent reviews, the LIBOR reform could even take place before the end of 2021. With little over a year left until the elimination of LIBOR, we take you through the background of LIBOR, transition trends, challenges faced and the approach of the Loan Market Association and Asia Pacific Loan Market Association.
LIBOR is a benchmark interest rate that indicates the borrowing costs between banks on a global level. LIBOR is currently administered by the ICE Benchmark Administration and is produced in several different tenors in US Dollars, Euros, British Sterling, Japanese Yen and Swiss Franc.
The transition away from LIBOR has led to the creation of overnight risk-free rates as alternative reference rates in respect of different currencies; and such overnight risk-free rates are widely preferred as they are premised on active (i.e. liquid) underlying markets. By way of examples, the Secured Overnight Financing Rate (SOFR), Sterling Overnight Index Average (SONIA) and Hong Kong Dollar Overnight Index Average (HONIA) have been identified as an alternative reference rate in relation to US Dollars, British Sterling Pounds and Hong Kong Dollars respectively. Overnight risk-free rates have also been created in relation to other currencies including Euros, Japanese Yen as well as Swiss Franc.
Switching from LIBOR to alternative reference rates is exciting, but presents many challenges to global banks and financial institutions at the same time. Before various overnight risk-free rates were established, LIBOR was the reference benchmark and calculation basis for a wide range of financial transactions. The difference in valuation between LIBOR and overnight risk-free rates can expose financial institutions to risks which can only be compensated by way of increasing the corresponding financing costs. With LIBOR being phased out by the end of 2021, banks and financial institutions are facing a race against time to familiarize themselves with the various overnight risk-free rates and their respective characteristics in order to provide financial services at minimal risk.
The LMA published the Recommended Revised Form of Replacement Screen Rate Clause and Users Guide (the Screen Rate Clause) on 21 December 2018. The Screen Rate Clause was prepared to facilitate amendments to be made to incorporate the use of a replacement benchmark rate into documentation and allows users to select when the provisions will be triggered. In light of the impending ouster of LIBOR, the Screen Rate Clause was adopted into the body of the APLMA recommended forms in March 2020. Banks and financial institutions are advised to review the Screen Rate Clause and consider its implication in the context of their existing and new transactions to prepare for the transition away from LIBOR.
Clyde & Co's Banking and Finance Team is experienced in a range of different financial transactions and is well-placed to help clients navigate the risks brought about by the transition of LIBOR. If you have any queries in relation to the LIBOR transition process and how to document the transition from LIBOR to alternative reference rates in your transactions, please feel free to contact us.