LIBOR Transition: Hardwired Language Rewired

Last week was quite eventful in the world of LIBOR transition, from the ARRC’s SOFR Symposium, to the passage of LIBOR transition legislation in New York for tough legacy contracts, to the release of supplemental fallback language for syndicated and bilateral loans. The hardwired language has come a long way- the original version was barely used, but the update last summer has achieved broad adoption in new and amended loans. What does the latest iteration have to offer, and is it worth adopting at this point?

Compared to the various versions of amendment approach language that have evolved in the market, the hardwired approach offers parties more certainty as to what the replacement benchmark will look like. The details that remain tend to be more administrative in nature and are hopefully less prone to disputes. That said, the 2020 hardwired language is hardly simple or easy to understand. Many of the details, such as the end date for LIBOR, the availability of SOFR and the spread adjustment, remained unresolved when the language came out. This necessitated drafting in the alternative and using broad descriptive language to cover concepts that would develop in the future.

Fast forward eight months to the March 5, 2020 announcements of the FCA and the IBA, and clarity on those and certain other details is now here. Rather than saying that LIBOR will one day be phased out, the date is fixed. Although Term SOFR is still a question mark, daily simple SOFR is operational now, so there is no need for loan parties to fumble around trying to figure out what the replacement rate should be. The formal announcement of the end of LIBOR also set the market-agreed calculation of the SOFR spread adjustments, which Bloomberg dutifully computed the same day.

All of these are good changes to update in the hardwired language. The question remains whether they are worth adopting at this time. In concept, it is simple enough to update the template forms for new loans. However, it involves more effort, coordination and time than one might expect and introduces yet another variation in the loan portfolio. The backdrop for these changes is that by the end of 2021, and preferably sooner, all lenders should stop originating LIBOR loans, even with updated hardwired language, and only originate SOFR loans. Different lenders are at different stages of readiness for this task, with some ready to make SOFR loans in the coming weeks and months, and others likely to be pushing the New Year’s Eve deadline. It is a monumental task involving many departments at a bank and requires substantial drafting and thought.

To the extent that revising the hardwired language detracts from this effort, a lender might determine that the existing hardwired language is good enough for the remaining LIBOR loans that it will make this year. If a lender is switching to SOFR by mid-year, it may not be so many loans. The ARRC drafted the 2020 language to encompass the SOFR future, however that future might develop. The value of the updated ARRC language is that it takes the recent developments and shows market participants the practical effect those developments have on the SOFR future. This benefit can be obtained whether or not the updated language is actually implemented in any particular loan agreement.

 

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. HuskinsPhuong (Michelle) Ngo, and Han Wang.

LIBOR Transition: Legacy Loans on the Backburner

Now that the formal end dates for LIBOR have been announced by the FCA, it’s time to consider some of the practical implications  of the announcement. With the original end date scheduled for the end of 2021, many in the market breathed a collective sigh of relief at the possibility of an extension of the deadline. Among all the other complicated tasks to be completed before LIBOR’s demise, getting borrowers, many of which are oblivious to the  coming change, to amend the millions of legacy loans originated before the end of LIBOR was even contemplated is a particularly daunting one.

Although the 1-week and 2-month US dollar LIBOR tenors will still end on December 31, 2021, the 1-month, 3-month and 6-month LIBOR tenors used in the majority of loans will now end on June 30, 2023. By design, this extension has a number of effects. First, it reduces the number of legacy loans that will need to be amended to replace LIBOR, since some of those loans will expire by their terms during the additional time period. Second, it gives a lender more leverage to amend some of its loans. A borrower that wants to extend a loan that is expiring or that wants or needs an amendment or waiver during such time will not be able to just say no to a new interest rate. Third, for all legacy loans, it gives lenders more time to prepare for and explain to their borrowers the coming change.

Delaying the amendment of legacy loans is not entirely advantageous to lenders. Since lenders will not be permitted to originate new LIBOR loans after 2021, extending the wind down of LIBOR lengthens the period of time during which lenders will have to maintain and keep track of LIBOR and the replacement rates. Delaying amendment of legacy loans will also delay adoption of the new rates, which can hinder their success, for example in the development of Term SOFR.

Still, with all the other tasks that remain to be completed, it’s good to be able to put a major part of the work on the back burner to focus on getting replacement rates operational. Legacy loans are not completely out of mind—the LSTA should be coming out soon with sample forms of LIBOR transition amendments and notices for syndicated loans, which can be modified for other loans. Perhaps by the time comes for them to be used, the transition of legacy loans will not be such an insurmountable task.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. HuskinsPhuong (Michelle) Ngo, and Han Wang.

LIBOR Transition: Is a Universal Descriptive Amendment the Answer to Amending All Those Loan Agreements?

Until now, LIBOR replacement amendments have mostly consisted of placeholder language that describes the process and principles that the parties will follow to transition to a new rate while the market works out the details of how the new rate will work. The variations have included a consensual amendment approach, a hardwired approach of mutually agreed preferred alternative rates with the lender to determine the details, and a lender discretion approach where the borrower has little if any say in what the replacement will look like.

Now that the phase out of LIBOR is on the horizon and the replacement details are starting to come together, it’s time to focus on what the actual amendments to delete LIBOR and insert a new rate into the countless LIBOR loan agreements should look like.  A traditional amendment approach would use surgical precision to delete every LIBOR definition and go section by section, and perhaps even sentence by sentence or line by line, to delete the use and effect of LIBOR throughout the agreement, then do the same thing to add in the provisions for the new rate.  This approach depends on detailed due diligence of the underlying loan agreements.  Absolute precision is required to do it right- if the wrong term is used because a template definition was changed in a particular loan agreement, or the wrong section is referred to because a template provision was moved in a particular loan agreement, the amendment will also be wrong and won’t work.  Precision takes time and money, and it’s not clear that borrowers will want to honor their obligations to pay for expensive loan amendments that they never wanted in the first place.

Since no one is perfect, should we just tolerate sloppy drafting when it happens, or is there a better way?  As complicated as it can be to amend countless loan agreements, the concept is simple—after a specified date, all LIBOR terms and provisions will be deleted and replaced with new SOFR (or Ameribor or some other rate) provisions.  Why can’t the amendment just say that?  The drafting required isn’t literally that simple, but this type of universal descriptive amendment should be able to amend almost any loan agreement without knowing exactly what LIBOR terms are used, exactly where they are used or exactly what the LIBOR provisions say.

Our recent Alert discusses how a universal descriptive amendment might work and the potential advantages it may have to successfully achieve LIBOR transition.

Duane Morris’ LIBOR Transition Team:  Roger S. Chari, Chair, Joel N. EphrossAmelia (Amy) H. HuskinsPhuong (Michelle) Ngo, and Han Wang.