On January 28, 2021, the UK Loan Market Association (LMA) published exposure drafts of two multicurrency term and revolving facilities agreements which incorporate, among others, backward-looking compounded risk-free rates (the Exposure Drafts). In addition, the LMA published commentary on the Exposure Drafts, which aims to assist market participants in understanding the terms thereof. The Exposure Drafts are based on the LMA’s exposure draft switch rate agreements discussed in our earlier blog post. The LMA hopes that their publication will facilitate awareness of the issues involved in structuring multicurrency syndicated loans which use backward-looking compounded risk-free rates (RFRs).
The Exposure Drafts envisage that from the outset:
- Compounded RFRs will be used as the basis on which interest is calculated for US dollar, sterling and Swiss franc amounts. Parties should ensure that they are operationally able to enter into, and manage, such a structure.
- On the basis that EURIBOR will continue beyond the end of 2021, EURIBOR will be used as the basis on which interest is calculated for Euro denominated loans. Parties have the option to provide for the automatic replacement of EURIBOR with compounded €STR at a later date.
While one of the Exposure Drafts is based on an observation shift and the other is without an observation shift, they are identical save for the calculation provisions set out in Schedule 14 and Schedule 15. These schedules reflect the differences in calculation formulae for a lookback without an observation shift and a lookback with an observation shift, with the key differences being the weighting of the daily RFRs in the formula, and how such weighting is used to address non-business days.
Market participants should note that the Exposure Drafts apply the SONIA loan market conventions as recommended by the Working Group on Sterling Risk-Free Reference Rates (the SONIA Conventions) and should therefore consider whether the SONIA Conventions are suitable for use in each specific transaction and for each relevant currency other than GBP. In particular, market participants should note that the Exposure Drafts do not reflect the conventions recommended by the US Alternative Reference Rates Committee (the ARRC Conventions) for SOFR, which we discussed in our earlier blog post. Whilst there are certain similarities between the SONIA Conventions and the ARRC Conventions, there are also a number of differences. Parties are able to adapt the Exposure Drafts such that the appropriate approach can be specified for each relevant currency.
The publication of the Exposure Drafts is a welcomed step in the efforts to transition to the use of RFRs in loan products. It is, however, imperative that individual market participants carefully consider the Exposure Drafts in the context of each specific transaction and form their own view of the extent to which they are suitable for use as the basis for preparing the loan documentation. This is particularly important as the Exposure Drafts are based on the SONIA Conventions, which may differ in certain aspects from conventions for other currencies.
Please contact any of the authors of this briefing or your regular McGuireWoods contact if you have questions about, or would like assistance with, the LIBOR transition.