In 2013, a wide range of changes were introduced in relation to the London Inter-Bank Offered Rate. A staple for a wide range of financial products, LIBOR has been the dominant rate for syndicated loans, bonds, and derivatives entered into on the Bulgarian, CEE, and wider European markets. However, following a series of problems over the past decade, the need to move away from LIBOR has become apparent. As panel banks would not be required to submit their references by the end of 2021, the question has become what the alternatives to LIBOR are and how they can be implemented.
Overnight Risk-Free Rates
At present, LIBOR is published for seven different borrowing periods in five different currencies: the US dollar, the Euro, the British pound sterling, the Japanese yen, and the Swiss franc. The main characteristics of LIBOR are its incorporation of banks’ credit risks for long-term lending activities and the fact that it is a forward-looking rate. However, none of the alternative risk-free rates (RFRs) put forward to replace LIBOR have comparable characteristics, and a single equivalent replacement rate has not been formulated. In addition, not all proposed RFRs are published yet (and their publishing times vary), and having multiple RFRs would potentially lead to IT hindrances for the currently operated systems.
As term-rate solutions have still not been put into effect, overnight RFRs are currently the viable alternative to LIBOR. Due to the lack of a concerted effort on the international level to come up with a single replacement rate for LIBOR, different overnight rates have been advanced for the various currencies currently published by LIBOR. These include: (i) SONIA (Sterling Overnight Index Average) – an unsecured overnight rate administered by the Bank of England; (ii) ESTER/€STR (Euro Short-Term Rate) – an unsecured overnight rate administered by the European Central Bank; SARON (Swiss Averaged Rate Overnight) – a secured overnight rate administered by the SIX Swiss Exchange; (iii) TONA (Tokyo Overnight Average Rate) – an unsecured overnight rate administered by the Bank of Japan; and (iv) SOFR (Secured Overnight Funding Rate) – a secured overnight rate administered by the Federal Reserve Bank of New York.
Term-Rate Alternatives to LIBOR
These RFRs are not suitable for the purposes of the syndicated loan markets. Thus, term-rate alternatives have to be established, with the two main alternatives put forward by the Loan Market Association (the LMA) based on either (i) forward-looking overnight index swaps that reference RFRs, or (ii) backward-looking term rates that are compounded over a certain period of time.
At present, no forward-looking rates have been established. The various working groups are at different development stages, with: (i) a term rate for Sterling that may be available for Sterling in the first three months of 2020, depending on the liquidity of the overnight index swaps market; (ii) the ARRC working on having an administrator to produce a forward-looking rate for US dollars, but only once the SOFR market for derivatives is liquid enough; and (iii) the Euro Working Group set to produce a plan for evaluating fallbacks to EURIBOR which are either forward- or backward-looking.
Backward-looking rates are being evaluated by all working groups.
Changes to the Credit Documentation and the Bulgarian Perspective
The LMA has issued several notes and recommendations for the upcoming transition, including a new clause in the loan documentation for replacing screen rates. The purpose of such a clause is to produce a solution for the new credit lines in the transition period, whereas for the existing exposures the lenders will propose amendments to the loan documentation already in force. The expectation that lenders will propose such amendments could be problematic, especially if the exposure occurs during the restructuring phase or if the borrowers do not agree with the approach being proposed. In this respect, the LMA is proposing to work on a form of reference rate selection agreement that can be entered into by parties to an LMA-based facility agreement to streamline the amendment process.
The Bulgarian syndicated market makes no exception to the use of LIBOR. As the majority of the lenders in Bulgaria are majority-owned by larger European financial groups, the intention on the local market is to wait for a group decision to be put in place, and subsequently to follow suit. In practice, Bulgarian banks are well-positioned to transition to an alternative rate, as they went through a similar exercise in the past year: in June 2018, the Bulgarian National Bank stopped publishing the SOFIBOR term rate, which forced the local credit institutions to amend a significant number of loan documents within a short period of time. Thus, the market will not be unprepared to face the challenges that will arise through the discontinuation of LIBOR
Dimitar Zwiatkow, Partner, and Ivan Gergov, Associate, CMS Sofia