Borrowers and lenders who want to retain economic control of their contracts and ensure against any contractual uncertainties should be working together to actively transition their LIBOR-referencing loan agreements, where possible.

The end-Q3 2021 milestone on the roadmap of the Working Group on Sterling Risk-Free Reference Rates (Working Group) is that by that date market participants should complete the active conversion of all legacy sterling LIBOR contracts expiring after end-2021 and, if not viable, ensure robust fallbacks are adopted where possible.

Here we look at some commonly asked questions from borrowers and lenders at this stage in the transition journey.

Do we have to switch away from LIBOR now?

No. While contracts can be amended with immediate effect they can also be amended at a future date. By inserting a switch mechanism into the contracts the change to the alternate rate, be it SONIA or another rate, can take effect at a specified date, such as at the end of an interest period or on an interest fixing date, or on the occurrence of a future event, such as the date on which LIBOR is deemed to be unrepresentative.

The Working Group have suggested, for example, that the last interest fixing before end-2021 can be based on LIBOR, with the move to an alternative rate taking place on the first fixing date in 2022. This is reflected also in the Loan Market Association's (LMA) recommended form of rate switch language which allows LIBOR to continue to apply to interest periods which have commenced prior to the relevant rate switch date. Where this switch wording is used the new risk free rate would start to apply from the first day of the next interest period for that loan. In the spirit of active transition, however, and to enable a speedier switch away from LIBOR, the LMA does also make (optional) provision for interest periods for loans referencing LIBOR to be ended early (i.e. on the applicable rate switch date) in certain circumstances, for example where the rate switch date was known at the time the interest period was selected.

Are there reasons for making the switch away from LIBOR sooner rather than later?

Yes. It is anticipated that liquidity in sterling LIBOR could decrease as we approach the end-2021 deadline so issues and costs for borrowers arising as a result of reduced liquidity could be avoided by making the switch earlier. SONIA on the other hand is based on active and liquid underlying markets so is stable and robust.

Also, on a more practical level, there is a possibility as we draw towards the of the year that there could be time and resource constraints, what the Working Group called "a collective compression risk" or a "squeeze in IT, legal or other resources" as the FCA put it. Transition activity is happening on a massive scale so professional as well as internal resources could become stretched. Any legal advice required should be sought promptly and any systems and processes changes to accommodate a new rate should be put in motion as soon as possible.

We are okay if our contracts have fallbacks, aren't we?

This depends on how effective and suitable the fallbacks are, and that needs to be thoroughly assessed. For example, do the fallbacks specifically anticipate the end of sterling LIBOR and do they provide a smooth transition to an alternative reference rate at a suitable point? If they do, and the fallbacks are assessed to be contractually robust, then they can be an effective route to transition, but if not then the Working Group recommends that they should not be relied on as a primary transition mechanism.

If we cannot amend our contracts in time can we use synthetic LIBOR?

The FCA is currently consulting on a proposed synthetic LIBOR rate to be determined under a modified methodology for more widely used 1-, 3- and 6-month sterling (and Japanese Yen) LIBOR but, as we have discussed here, we don't yet know (and won't know until Q4) what would qualify as a 'tough legacy contract' to use the synthetic rate, and the synthetic rate would be time limited so does not remove the need to transition contracts running beyond the relevant synthetic LIBOR timeframe. Active transition is the best way for borrowers and lenders to retain control over the economics and operation of their contracts.

If you have any questions about LIBOR transition please contact us.


Lindsay Lee

Senior Associate