LIBOR no more: Effects on lender and borrower arrangements

The normal rate on which corporate lending and leasing (and some other facilities’) interest is currently based is LIBOR, which provides forward-looking rates that are applied to calculate the rate of interest, for various borrowing periods, in advance. LIBOR is used internationally, and is quoted in a wide number of currencies.

However, LIBOR will no longer be available from the end of 2021, and there is not yet an agreed replacement rate. Latest developments mean that different countries will most probably use their own local reference rates (and these possibly will apply to UK loans drawn in other currencies): SONIA in UK, SOFRA in USA, ESTER/€STR in Eurozone.

What does this mean in practical terms?

Each of these screen rates currently are available, but only provide backward looking rates – so you know what the interest rate is only once it has been applied, which makes projections and budgeting more difficult. In addition, these rates were designed as overnight rates and so will change daily rather than setting a rate that you know will not change for three months, six months or whatever. And they don’t take into account lenders’ credit risk, so an additional element will need to be added to the replacement screen rate to calculate the actual rate that will be charged.

As a result, the rate that applies under existing loan agreements will change once the applicable replacement rate has been adopted. Where your loan agreement already provides for changing the basis for interest to apply, and most will, it might be worthwhile checking before LIBOR ceases, to see what that will mean to those loans, what costs are likely to be incurred, and who has the right to decide on the applicable replacement rate.

Where you have hedging arrangements, then you may already see reference to SONIA (Sterling Overnight Index Average) or other replacement reference rates in the documentation. For traditional lending transactions however, SONIA does not yet provide an answer – although there is a lot of work going on to make it work before LIBOR disappears. At the moment, it is tricky to include SONIA or any other alternative rate for debt finance, since the definitions cannot be pinned down, the actual replacement rates are not agreed yet and we don’t know yet exactly how they will be calculated.

The Bank of England Working Group on Sterling Risk Free Reference Rates issued a discussion paper on possible conventions for referencing SONIA in loan documentation and has now issued a statement on progress towards adoption of a Term SONIA Reference Rate (TSRR) in Sterling markets. There is a general assumption that the market will move towards use of a TSRR, with work focussing on development of a forward-looking TSRR that would give the borrower some advance notice of the interest payment which would apply. It is also generally expected that transition from LIBOR, to the greatest extent possible, will progress independently of the development of a TSRR.

We will continue to update you as the position evolves, and in the meantime discuss with your legal team if your existing loan agreement refers to LIBOR. Although we have until the end of 2021 before LIBOR will stop being widely used, we expect that new agreements will start to refer to the replacement rate in readiness as soon as that rate is agreed.


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