The transition away from LIBOR is imminent and lenders and borrowers should be thinking about how this will impact on both new and existing finance transactions.
As USD is the most prevalent LIBOR currency used in shipping transactions, this article focuses on the current position as it relates to USD LIBOR.
The current position
On 30 November 2020, ICE Benchmark Administration (IBA), the administrator of USD LIBOR and other IBORs, announced that it would hold a consultation on its intention to extend most USD LIBOR tenors until 30 June 2023. The IBA consultation paper was subsequently published on 4 December 2020 and included proposals to: (i) cease the publication of one-week and two-month USD LIBOR settings after 31 December 2021 and (ii) extend publication of the other remaining LIBOR tenors (i.e. the more widely used overnight, 1, 3, 6 and 12-month USD LIBOR settings) until 30 June 2023. The consultation was open for feedback until 25 January 2021.
On 5 March 2021, IBA published a feedback statement for the consultation. This statement confirmed that:
- Publication of all EUR LIBOR settings, all CHF LIBOR settings, all JPY LIBOR settings, all GBP LIBOR settings and the 1-week and 2-month USD LIBOR settings will cease immediately after 31 December 2021, unless the FCA exercises its proposed to new powers (which are included in the current Financial Services Bill as proposed amendments to the UK Benchmarks Regulation) to require IBA to continue publishing these LIBOR settings using a changed methodology (also known as a “synthetic” basis).
- Publication of the overnight, 1, 3, 6 and 12 month USD LIBOR settings will cease immediately after 30 June 2023 unless the FCA exercises its proposed to new powers to require IBA to continue publishing these LIBOR settings on a “synthetic” basis.
The FCA has advised IBA that it has no intention of using its proposed new powers to require IBA to continue the publication of any EUR or CHF LIBOR settings, or the overnight/spot next, 1 week, 2 month and 12 month LIBOR settings in any other currency, beyond the above intended cessation dates for such settings. The FCA has also advised IBA that it will consult on using these proposed new powers to require IBA to continue the publication on a “synthetic” basis of the 1 month, 3 month and 6 month GBP and JPY LIBOR settings beyond such dates, and will continue to consider the case for using these proposed powers in respect of the 1 month, 3 month and 6 month USD LIBOR settings.
What will replace USD LIBOR?
The Alternative Reference Rates Committee, convened by the US Federal Reserve to oversee the transition process for US dollars, has named the Secured Overnight Financing Rate (SOFR) as its recommended alternative to USD LIBOR.
SOFR represents the cost of borrowing cash overnight in the interbank market, collateralised by US treasury securities. Therefore, unlike LIBOR, it is based on actual market activity, rather than estimated quoted borrowing rate.
For more information about SOFR and how it differs from LIBOR please see this Reed Smith client alert.
Preparing for change – existing loans
Investors, banks and companies active in the shipping sector should start now with the exercise of examining their books for transactions using non-USD LIBOR which run past 31 December 2021 and those USD LIBOR transactions which will mature after mid-June 2023.
Some of these deals will have been documented before the discontinuation of LIBOR was contemplated. Taking loan agreements as an example, if the parties cannot agree to amend a loan agreement in order to allow for a revised mechanism for rate setting, the market disruption provisions in the agreement will usually apply. These provisions tend to assume that the non-publication of LIBOR is temporary and provide that an interpolated LIBOR is used which, if not available, is replaced by reference bank quoted rates or a bank’s cost of funds. Many banks are now reluctant to act as reference banks and are very resistant to revealing their cost of funds. As such, this leaves room for negotiation and prevarication by borrowers.
When it comes to loan agreements, we anticipate that amendment agreements will need to be entered into on a loan-by-loan basis, with consents potentially required from borrowers, guarantors, export credit agencies, risk insurers and, in some cases, charterers. This will all take time.
If they haven’t already, market participants should start assessing their positions and getting ready for the upcoming negotiation, consent and amendment exercise. It will pay to be prepared – so it will be key to know your voting power, consent rights and potential fallback position.
One point to note from a shipping perspective is the likely need to register amendments or supplements to existing mortgages. Different flag states have different laws and practices, which will each need to be examined to determine whether mortgage amendments are required. However, mortgagees are likely take a cautious approach in order to ensure that they continue to be fully secured in the context of a new method of determining the rate of interest.
Preparing for change – new loans
The majority of English law ship finance transactions are based on Loan Market Association (LMA) documents. As such, this article focuses on the LMA LIBOR transition drafting options available for parties entering into new shipping loans.
Ship finance lenders and borrowers of US dollar loans currently have three options:
- Include the most up to date LMA Replacement of Screen Rate clause. This clause provides that the parties will negotiate in good faith to replace the interest provisions at a future date with a new benchmark. The parties need to agree on a date from which the negotiations will start and another date by which they will end (such dates are likely to reflect the deadlines set out by the applicable regulatory regimes). This gives time for lenders and borrowers to agree the commercial terms for the new rate, but also means that supplemental agreements will eventually need to be entered into in order to amend the interest provisions.
- Include a “rate switch” mechanism allowing interest to be calculated on the basis of a new benchmark upon the occurrence of a trigger event. On 11 September 2020, the LMA published an exposure draft multi-currency term and revolving facilities agreement, which includes rate switch mechanism provisions reflecting the recommendations of the Working Group on Sterling Risk-Free Reference Rates. This allows parties to rely on LIBOR until its discontinuation, whilst also having a mechanism to switch to the new rate thereafter. However, the parties would need to agree upfront the commercial terms relating to the new rate.
- Base the loan agreement on the chosen benchmark (i.e. SOFR) from the outset and not refer to LIBOR at all. This avoids the need for future negotiations and supplemental agreements, but market practice is yet to settle and the LMA has not yet published an updated recommended form.
Some shipping lenders have already started documenting loans using the new benchmark rates. For example, in November 2020 it was reported that Seastar had signed a new loan with a SOFR switch mechanism based on the LMA Rate Switch Agreement.
In addition, in autumn 2020, Grieg Maritime Group agreed to be part of a pilot project with DNB. The parties entered into a SOFR-loan in relation to the refinancing of one of Grieg Maritime Group’s handy bulkers.
We shall be carefully watching the market over the coming months to see how participants start to deal with the transition away from LIBOR, both in terms of their existing deals and in documenting new transactions.