At the end of 2021 it is expected that LIBOR will cease to be published. While some in the market appear to be awaiting forward looking term rates to use as a replacement benchmark, regulators (and their working groups) have encouraged market participants not to wait and have a target of no new £LIBOR loans to be issued from the end of Q3 2020.
What will happen if documentation remains unamended?
Assuming LMA documentation has been entered into, the screen rate, interpolated screen rates and (ultimately) historic screen rates will be unavailable. Reference banks will likely not offer a rate.
A lender will have 5 Business Days to calculate its ‘cost of funds’. This, even for a bank lender could be an impossible calculation. It’s anticipated to involve each individual bank working up a calculation based on the rates at which it is borrowing in the interbank market. However, these rates will not mirror the term or quantum of the underlying participation.
With the market share of credit funds ever increasing and the Bank of England estimating that non-bank investors hold $1.8tn of leveraged loans, perhaps a more significant question is: how would a credit fund lender calculate their ‘cost of funds’?
There is no established practice to this calculation and no interbank funding to take into account. Most credit funds have their own borrowing at fund level. If in sterling, this may also reference LIBOR as a benchmark and a fund could be subject to their own lenders' ‘cost of funds’ calculations. Would the cost of borrowing under the fund financing even be an appropriate cost to put forward as a ‘cost of funds’? A credit fund may not be bridging commitments from LPs or borrowing at all. Should it be considered how the loan participation could otherwise be put to work? How would a fund establish its costs of drawing commitments from LPs?
Many borrowers expect their lenders to address LIBOR concerns. It is in the gift of the lender to calculate its ‘cost of funds’ and although the lender will usually be required to "reasonably select" the new rate, there is typically no requirement to provide any supporting calculations. If the cost arrived at is in excess of LIBOR (as quoted prior to discontinuation) could a borrower challenge this on the basis that the lender agreed a LIBOR-based return and the discontinuation of LIBOR should not result in a windfall for that lender?
Current fall-back language is not the solution.
Market participants are always hopeful that even newly crafted fall-backs will not be used, but to avoid this, hundreds of billions of pounds worth of legacy loan documentation will require amendment within the next 22 months.
Further thoughts on LIBOR transition can be found in Jamie Macpherson's article on "Leaving LIBOR: Lenders in transition".