Deep divides will form as loan providers prepare to ditch Libor
The syndicated loan market is facing a schism in the way it deals with the transition away from Libor — and unless the famously ponderous market starts to co-ordinate fast, fissures will keep appearing as different regions stick by their favoured replacement benchmark rates.
The US Alternative Reference Rates Committee (ARRC), the US trade body dealing with the Libor transition for dollars, has pinned its colours to the mast and declared that the loan market should use a “hardwired approach” to move away from Libor.
This approach lets the borrower or its agent replace Libor with either the term or daily Secured Overnight Financing Rate (Sofr) without needing to gain consent from the lending syndicate — though the lenders will, of course, be notified. The alternative is the “amendment approach”, which tinkers with terms and requires lenders give the thumbs-up.
Hardwiring has undeniable benefits. If implemented well, it codifies the process, so everyone involved knows exactly what comes next at each stage. It will also speed up the transition. Considering that Libor is due to be dumped at the end of 2021, and regulators are pushing for lenders to find a solution well before then, speed is a strong motivator in picking a methodology.
However, this all works only if the hardwired approach is well thought out and, despite all the most prominent stakeholders in the loan market being involved in working groups for many months to solve the problem, there are indications that it will still end up being something of a rush job.
The first major red flag is that a hardwired approach has never been used in the loan market. Proponents of hardwiring point to other comparable markets — such as that for floating rate notes — which have successfully used the method. But if FRNs and syndicated loans were identical, then there would be no need for both markets to exist. The devil is in the detail, and it would be helpful if the loan market could at least have a few data points of hardwired transition to look at and see if there were any unforeseen niggles that need to be addressed before it can be taken to market.
The second flag is that not all the conventions for a hardwired approach have been finalised. Major ones have —such as the definition of daily Sofr, for example — but there are still smaller conventions missing from the guidance. ARRC plans to fill in the gaps before the deadline.
Without all the conventions in place, some level of interpretation will be necessary from a loan agent and the borrower. ARRC is planning for these interpretations to be necessary and recommends that the agents and borrowers make the decision without syndicate consent. Agents are happier to do this in the US than in Europe, where there is some pushback from banks in making decisions without putting it to the wider syndicate.
What this will probably lead to is a different method taken by lenders in dollars and sterling. Add to this that Euribor will continue to exist, and there are now at least three different methods that could be used on one multicurrency facility.
People working close to the matter stress that, from a documentation standpoint, this will add another layer of complexity but is perfectly doable. But this brushes over a seemingly largely forgotten party in any loan: the borrower.
The corporate market has been unenthusiastic about the shift from Libor. While the Libor scandal undoubtedly showed the benchmark as liable to abuse, for many corporates’ day-to-day needs it was not broken and did not need fixing. Major trade bodies have the point of view that this is a bank issue and they are being dragged into something that corporates, as bank clients, shouldn’t have to worry about. It’s hard not to agree with that point of view.
A likely common occurrence in the medium term will be a UK bank, for example, explaining to a chief financial officer that if they want to draw sterling from their multicurrency facility, it is going to be priced in a different way from any dollar or euro drawdowns they make. This is going to be, at best, the cause of many a CFO eye-roll as they start to wish that their lending bankers had just got it done better and sooner.