UK Supreme Court narrows the scope of the restraint of trade doctrine in landmark ruling
Out-Law Legal Update | 06 Nov 2019 | 4:47 pm | 6 min. read
Trade body the Loan Market Association has published for consultation its proposal for what loan documents might look like after the discontinuation of LIBOR, at the end of 2021.
The London Interbank Offered Rate (LIBOR) is used as a reference rate for trillions of pounds worth of financial products globally. The use of LIBOR as a reference rate will come to an end after 2021, creating huge ripple effects across the loan markets, which heavily rely on LIBOR to calculate interest and other payments due from borrowers.
The expectation is that LIBOR will be replaced by the Sterling Overnight Index Average (SONIA) for many loan documents after 2021. SONIA is published by the Bank of England and represents the weighted average of unsecured overnight sterling transactions. It is what is referred to as an 'overnight risk free rate' and is fundamentally different to LIBOR in a number of respects.
These differences will have a substantial impact on how loan agreements are drafted and operate. The Loan Market Association, he trade association for the UK syndicated loan market, haspublished its compounded SONIA based sterling term and revolving credit facilities agreement 'exposure draft' for consultation.
The LMA has been careful to stress that the exposure draft should not be treated as market standard documentation. However, whilet it represents a significant step towards what loan documents may look like once LIBOR has been discontinued, the exposure draft also exposes the significant steps still required to be made by the UK loan markets before the transition from LIBOR in 2022.
The exposure draft provides for interest payments to be calculated by reference to a 'compounded SONIA' screen rate, meaning an average or aggregate calculation of SONIA over a certain set time period, as published by a third party. This approach mirrors the approach that has been taken for SONIA referenced interest payments in the floating rate bond market.
The exposure draft envisages that the borrower's interest rate under the loan agreement will be calculated by reference to the compounded SONIA rate for what is referred to as the 'observation period'. The observation period is a period equal in length to the borrower's interest periods under their loan agreement, but which lags a number of days behind each interest period. This is the lag time). Borrowers will be notified of the amount of their interest payments at the end of the observation period, with the lag time intended to provide sufficient time for any administrative steps to be completed before the borrower is due make payment.
If the relevant compounded SONIA calculation has not been published, the responsibility for calculating compounded SONIA would fall to the agent under the loan agreement.
While its publication is a significant step forward, the exposure draft has exposed the gaps in the loan markets’ progress towards a future without LIBOR.
There is currently no published compounded SONIA screen rate. In the absence of a published rate, under the terms of the exposure draft, the agent would be responsible for calculating compounded SONIA for each observation period under the loan agreement. However, parties may find agents reluctant to take on the responsibility for calculating the rate without sufficient protections under the loan document. It remains to be seen whether this increase in responsibility could result in an increase of agents' fees for borrowers.
LIBOR is published for a number of forward looking 'tenors' or time periods, such as overnight/spot next, one week, one month, two months, three months, six months and 12 months. This allows borrowers to know, at the outset of their interest period, what their interest payment will be at the end of that period. Most loan agreements are structured in such a way as to assume that a forward looking, or term, reference rate is available.
Currently, no such 'term SONIA' screen rate is available. This absence is one of the primary reasons why the exposure draft has been published by the LMA. The SONIA calculation for a particular day or time period cannot be ascertained until the following day, and therefore necessitates a significant change to the way many borrowers' interest rate mechanics operate in their loan agreements.
The LMA and other industry bodies have been vocal in their support for the publication of a 'term SONIA', emphasising the importance in the loan market for many borrowers to be able to ascertain their interest payments at the outset of their interest period.
Whilst it is likely that a 'term SONIA' screen rate will be published in the future, in the interim, borrowers and lenders should not be delaying their LIBOR transitioning plans. If 'term SONIA' does not become available before 2022, loan agreements that currently reference LIBOR will need to transition to another reference rate, such as compounded SONIA or another alternative, such as base rate or fixed rate lending.
In line with existing LMA loan documentation, the exposure draft continues to provide for break costs to be payable by a borrower in the event they repay their loan early. Break costs are intended to compensate the lender in circumstances where they have funded a borrower's loan by 'match funding'. Match funding refers to the process by which the lender would borrow the loan amount on the interbank market for a period equal in length to the borrower's interest period. As the lender will be obliged to continue to pay interest on their match funding for the length of the interest period, they may suffer a loss is a borrower elects to repay their loan early.
However, following a transition to SONIA, it is arguable that lenders will be funding themselves, at least notionally, on a rolling overnight SONIA basis. As such, break costs may less of a concern for lenders following the transition away from LIBOR – although the market may take some time to adjust on this point.
The exposure draft acknowledges that the lag time is a matter to be commercially agreed between the parties on a transaction by transaction basis.
The purpose of the lag time between the end of the observation period and the end of the borrower's interest period is to provide borrowers and agents with sufficient time to ascertain the amount of interest due and to carry out any necessary administrative steps to allow for that interest payment to be made.
Borrowers and agents will be required to consider the amount of time they will require between the end of the observation period and the interest payment date to ascertain, communicate, and ensure payment of due interest. Parties must bear in mind that the longer the lag time agreed or required, the less reflective of the current market the borrower's interest payment is likely to be.
The period of lag time required may vary by product type, sector and customer type. This may lead to different lag times becoming market standard in different scenarios, which, by contrast with the common standards offered by LIBOR, may create additional administrative burdens for the loan markets.
The LMA has stressed that the exposure draft should not, at this stage, be treated as a market-agreed position for SONIA -referenced lending arrangements. On that basis, it is anticipated that the loan market is unlikely to see large scale documenting of loan agreements on the terms of the exposure draft in the immediate future.
Uptake of SONIA-referenced lending has so far been slow, with examples being widely published, such as the recent NatWest amendment with South West Water, and NatWest’s inaugural SONIA referenced loan with National Express.
Regulators and working groups continue to stress the need for loan markets to move away from loans made on LIBOR terms and start actively managing the transition to risk-free rates such as SONIA. In late October the LMA published its exposure draft Reference Rate Selection Agreement. The selection agreement is intended to "streamline the process of transition" for legacy loan transactions documented on LIBOR, encouraging parties to agree the basic commercial terms of their transition to SONIA in advance of formal amendment. It remains to be seen whether market participants will use the Reference Rate Selection Agreement or move straight to formal amendment of their lending documentation.
While many lenders will be approaching this repapering exercise cautiously, in this interim period borrowers and lenders should be actively identifying the extent of their LIBOR exposures in their financial products and putting in place robust LIBOR transitioning plans to avoid being caught out, come 2022.
Rachel Coleman is a loan markets specialist at Pinsent Masons, the law firm behind Out-Law.
06 Nov 2019
UK Supreme Court narrows the scope of the restraint of trade doctrine in landmark ruling