The Loan Market Association has over the last few weeks published exposure drafts of forms of loan agreement referencing risk free rates for new transactions, and a form of agreement with lenders as a first step to agreeing to amend legacy LIBOR loan agreements for alternative reference rates.
On the 25th October 2019 the LMA published an exposure draft of a Reference Rate Selection Agreement to facilitate the amendment of legacy loan documentation referencing LIBOR. This takes the form of an agreement for the borrower and lenders under a legacy LIBOR loan agreement in LMA format, to agree to amend the relevant provisions to calculate interest by reference to an alternative rate.
The Reference Rate Selection Agreement alone does not make the necessary drafting changes itself, it is a binding summary of agreed terms which will need to be supplemented by a formal amendment agreement by reference to the specific provisions of each loan agreement. It is step one of a two-step process. It authorises the Agent and the Obligors to determine the necessary amendments by reference to the LMA recommended forms of compounded risk-free rate facility agreements so that only the Agent and the Obligors will need to enter into the subsequent loan amendment agreement which may make the process of amendments easier to manage. In practice, many loan agreements entered into since the market has known that LIBOR will be transitioned, do not require all lender authority to make amendments to move to alternative reference rates, instead introducing a majority lender approval. Where all lender approval is required under the legacy loan agreement however, a Reference Rate Selection Agreement could be useful to authorise the Agent to approve the amendment agreement without further reference to all lenders.
The exposure draft of the Reference Rate Selection Agreement is made up of three parts:
(i) a summary of the scope of the amendments to transition to the chosen alternative reference rate and an authority for the agent to enter into an amendment agreement covering the terms agreed in the Reference Rate Selection Agreement, and signature pages;
(ii) the Selection Sheet with the basic agreed terms of how the chosen alternative reference rate will be utilised in a tick box format – for example fall-back rates, agreed lag time for calculating the interest period and observation period, agreed margin adjustment, optional interest periods, operation of market disruption provisions, break costs, any conditions precedent (which will include the subsequent amendment agreement), the effective date for amendments and whether the costs of the amendments are to be met by the borrower, the lenders, or by each party for their own costs; and
(iii) the terms and conditions applicable to the selection of the alternative reference rate – these expand on the terms set out in the Selection Sheet which are to be documented in the subsequent amendment agreement.
As noted, where loan agreements already provide that amendments to facilitate LIBOR transition may be approved by Majority Lender consent, the need for a preliminary agreement for all lenders to set out agreed terms may be unnecessary, but the Reference Rate Selection Agreement is nevertheless a useful aide memoire for parties to address all the necessary changes in a formal amendment agreement.
On the 23rd September 2019 the LMA published exposure drafts of Compounded Risk Free Rate Facility Agreements by reference to SONIA and SOFR, being the chosen replacement near risk free rates for LIBOR in the Sterling and USD markets respectively. The LMA published commentary with the drafts inviting comments from market participants on various structuring issues which need to be considered if adapting them for use in live transactions such as:
- Adjusting the risk free rate to reflect term bank credit risk and term liquidity premium;
- Use of a “lag” structure to ensure borrowers have advance notice of interest payments due, and whether shorter interest periods can practically be offered to borrowers where a “lag” structure is adopted;
- Fall-back rates where risk free rates are unavailable;
- Measuring break costs; and
- Operation of market disruption provisions and measuring costs of funds of lenders.