A replacement for Libor – but what about existing agreements?

Libor is the base rate used to calculate interest payable under most floating-rate commercial loan agreements, including most of those entered into by housing associations.

Since the announcement was made in July 2017 that Libor will effectively be discontinued, a lot of work has been undertaken by the Loan Market Association (LMA), the Bank of England and others around what interest benchmark will replace Libor and how interest provisions in loan agreements will be documented going forward.

This has led most recently to the publication by the LMA of wording that it recommends be considered for inclusion in any new loan agreements.

In summary, this wording provides that the choice of any replacement base rate and the inclusion of any related provisions are matters for agreement between the borrower and its lenders.

But what if any such agreement cannot be reached?

And what about those loan agreements that do not address what will happen if publication of Libor is discontinued?

It should be noted that Libor-based loan agreements will typically provide for a temporary replacement in the event of unusual market conditions, but it is questionable whether these sorts of provisions will be effective in the event of Libor being permanently unavailable.

One possible solution would be to adopt a protocol system, based upon that promoted by the International Swaps and Derivatives Association (ISDA) in the interest rate swaps market.

Under this system, ISDA periodically publishes suggested standard form wording to deal with new developments. As an example, the first protocol dealt with the introduction of the euro.

Market participants can decide whether or not to sign up to individual protocols – by doing so all the ISDA Master Agreements that they have signed are automatically varied, so long as the other party to that agreement has also signed up to the same protocol. ISDA keeps a register of who has signed up to which protocol, which is available on its website.

Up to now, there seems to have been no appetite for this approach to be taken in the loan market where there is no precedent for its use, and possibly also because there are a greater number of participants.

It could be argued also that if a borrower could be persuaded to sign up to a market protocol then it should be possible to get them to sign up to a simple variation letter making the necessary interest rate changes.

The only solution that could automatically apply to all loan agreements governed by English law looks to be a legislative one.

Under this approach, there would need to be an act of parliament setting out how references to Libor would be interpreted in all English law-governed loan agreements which refer to it.

It would set out a replacement interest rate benchmark that would apply and a series of consequential amendments that would be automatically read into all agreements.

In order for this approach to be widely acceptable, it should allow for contracting out for those borrowers that have agreed with their lenders that a different mechanism should apply.

In that way, recalcitrant borrowers will be encouraged to engage with their lenders on this issue, otherwise the default provisions of the act would automatically apply.

This has been the solution adopted in the past by banks undertaking a reorganisation or merger on the basis that it would not otherwise be practicable to get all their customers to agree to the proposed arrangements.

An example of this approach can be found in the HBOS Group Reorganisation Act 2006, which provided for the transfer of Halifax’s business to Bank of Scotland.

This all assumes, though, that a market consensus will emerge as to what interest benchmark should replace Libor and on what terms. It also needs parliament to be persuaded that this is a sufficiently important issue to be allowed parliamentary time.

Given the amount of business transacted in Libor and the importance of financial services to the UK economy, this looks to be a reasonable ask.

Neil Waller is a partner at Trowers & Hamlins.