Loans disclosure
Ensure that you're familiar with the provisions of any loan agreement that you have with us - including the interest rate fallback provisions or any replacement of screen rate clause that may appear therein.
The existing interest rate fallback provisions in loans were generally not designed to deal with a permanent benchmark cessation, as opposed to a benchmark’s temporary cessation.
The interest rate fallback provisions in your loan document, therefore, may not be robust enough to survive a permanent cessation. This could see the benchmark fall back to a rate that you didn't envisage at the time you entered into the loan, or it could go to a rate that is materially different to the current rate of the loan.
In loans, the ultimate fallback rate is often what is known as the lender's cost of funds.
A loan agreement may also include provisions to replace the benchmark in certain instances. The Loan Market Association (LMA), as well as the Asia Pacific Loan Market Association (APLMA), have published what is known as a 'Replacement of Screen Rate clause', which has also recently been updated. This clause permits flexibility in the choice of a replacement benchmark upon certain trigger events and specifies which consent level will be required from the majority lenders. The LMA has also published an exposure draft multicurrency agreement incorporating rate switch provisions, which aims to facilitate conversion from LIBOR before end-2021 through pre-agreed conversion terms.
To date, the interest on loans are based on term rates and calculated in arrears, and it’s not clear whether forward-looking benchmarks will be developed for these products and even if they are, whether they will be ready for use before the cessation of LIBOR particularly.
This means that the benchmark which your loan references may be replaced with a backwards-looking RFR.
The LMA has published a consultation paper setting out the structuring issues to consider when basing a loan on a backwards-looking RFR or when including the pre-agreed conversion terms. You should consider the issues raised in these LMA consultation papers.
You should also consider any mismatch there may be with the IBOR fallback provisions in your loan agreement versus the IBOR fallback provisions in any related hedge arrangements you've entered into. If there’s a material interest rate mismatch, it may result in basis risk or undermine the effectiveness of the hedge.