On 11th September the Loan Market Association published an exposure draft multicurrency term and revolving facilities agreement incorporating rate switch provisions (the Rate Switch Agreement). The draft is for the purposes of switching from an initial IBOR forward looking term rate referenced Loan in any currency determined by reference to an existing forward looking term rate, to an agreed alternative Risk-Free Rate calculated on a compounded basis on the occurrence of a pre-agreed date prior to 31 December 2021, or an alternative trigger event for any currency.
The draft is intended to satisfy the recommendations of the Working Group on Sterling Risk-Free Reference Rates made in their April 2020 statement and July 2020 Q&A that after the end of Q3 2020 lenders, working with their borrowers, should include clear contractual arrangements in all new and re-financed £LIBOR-referencing loan products to facilitate conversion ahead of end-2021, through pre-agreed conversion terms or an agreed process for renegotiation, to SONIA or other alternatives. The draft is also intended to reflect the Working Group’s recommendations for the SONIA Loan Market Conventions issued on 1 September 2020 adopting (i) a lookback without observation shift; and (ii) a non-cumulative compounded methodology for interest calculation.
The Rate Switch Agreement is a multicurrency agreement and applies the SONIA Loan Market Conventions to each referenced currency and the Risk-Free Rate corresponding to that currency but the LMA notes that users of the draft should consider the loan market conventions for use of Risk-Free Rates being developed separately by each currency-specific Risk-Free Rate working group (for example, the ARRC in the US has published its conventions for using SOFR in arrears for syndicated loans).
The Rate Switch Agreement drafting does not contemplate a switch to a term rate based on a Risk-Free Rate, such term rates not yet being available, and the Working Group having previously indicated that this would only be necessary in limited sectors of the sterling corporate loan market, for example, trade finance and Islamic finance.
A separate form of the Rate Switch Agreement containing a lookback with observation shift, which has been recognised in the SONIA Loan Market Conventions as a viable and robust alternative to lookback without an observation shift, will be published shortly.
The exposure draft is not a recommended form and the LMA invites market participants to comment on the various issues associated with the use of compounded Risk-Free Rates and the operation of SONIA loan market conventions set out in the accompanying commentary. Feedback should be sent to firstname.lastname@example.org and headed “Market feedback on Exposure Draft Rate Switch Agreement (Lookback without Observation Shift)” by close of business on Friday 25 September.
The draft Rate Switch Agreement and Commentary are available on the LMA website.