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LIBOR replacement and ship finance – where is it heading?23 November 2020

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The likely replacement of the LIBOR at the end of 2021 creates difficult technical and practical issues for all sectors of business and finance. The concerns intensify as the projected deadline grows closer against a background of some continuing uncertainty and lack of consensus about the details of the approach to take. Some recent developments are worth noting and putting in context for the shipping industry and ship financiers. There are issues both for loans now being documented – and also for all LIBOR-based deals likely to continue beyond 2021.

Looking at new loans first, what are the options? (Some of the key terms and abbreviations are set out in the glossary at the end.)

"The date now most frequently suggested for the start of negotiations is the end of Q1 although September seems to be the second favourite."

Provide for the agreement to be amended at a later date

This can be done by using either the LMA Replacement Benchmark wording, old ARRC wording or bank-bespoke wording. Where there is hedging in place this should be aligned so that there should be no mismatch. Increasingly, the additional LMA wording providing for discussions to start if LIBOR is still being used by an agreed date is being added. The date now most frequently suggested for the start of negotiations is the end of Q1 although September seems to be the second favourite. The LMA (and old ARRC) wording provides for borrowers to agree the amendments. In some bilateral facilities lenders seek a unilateral right to select the replacement.

Document now using an RFR from day one or with a switch mechanism using any of LSTA, APLMA, ARRC or LMA suggested drafting

Some lenders making new sterling loans have used SONIA as a benchmark, including one which has been documented by this firm – with others in progress. The position in relation to US dollar loans and the use of SOFR appears to be more cautious. US dollars are, of course, the dominant currency in ship financing – see more on this below. It seems that immediate use of SOFR in new loans has to date been restricted to some investment grade borrowers, often in relation to standby facilities and not in an asset finance context. That said, it is of interest that it has been recently reported that the bulk operator Seastar has closed a new loan with a SOFR switch mechanism based on the LMA Rate Switch Agreement.

ARRC hardwired approach

A combined alternative to the above two options was produced by the ARRC in June 2020 whereby a switch to an agreed waterfall of SOFR alternatives could be hardwired into a facility agreement leaving the finer details to be added later by way of amendment. They have said it should be used for US dollar LIBOR-based loans from 30 September 2020. The LSTA says this has started to be used and a number of banks have mentioned using the Hardwired Approach. However, in our experience, many have so far shown a reluctance to commit to a particular rate methodology (which is essential if it is to be hardwired) and have instead opted for the LMA Replacement Benchmark wording, or variations of this.

"Possible solutions mooted include UK legislative changes and – most interestingly and its favoured approach – the preservation of screen rate continuity by amending the feeds on the Bloomberg and Reuters LIBOR01 pages to display a successor rate."

Constructive thinking from the FMLC

A working group formed by the FMLC has written a paper which fully airs the issues. Possible solutions mooted include UK legislative changes and – most interestingly and its favoured approach – the preservation of screen rate continuity by amending the feeds on the Bloomberg and Reuters LIBOR01 pages to display a successor rate. This ingenious approach could mitigate the documentation remediation issues referred to below, including those specific to ship finance.

Uncertainty about US dollar deals?

Against this background, it is interesting that, in the last week, IBA has announced that it will consult the market on ending the publication of LIBOR rates for sterling, Swiss francs, euros and yen at the end of 2021 – but conspicuously and, perhaps significantly, did not include US dollars in that list of currencies. It says: “Discussions involving IBA, the Financial Conduct Authority (FCA), other official sector bodies and the panel banks are continuing regarding the future of USD LIBOR”. This creates yet more uncertainty for businesses which finance themselves in US dollars and for their lenders – and specifically for the shipping industry and might reinforce some slowness in moving unequivocally over to SOFR.

Existing US dollar LIBOR shipping loans

While the relevant bodies and authorities – and hence the market – continue to ponder or vacillate, there is also looming up with some urgency the issue of dealing with a switch in relation to existing LIBOR–based loans. This is a major documentation remediation exercise.

There is a further issue which is particular to ship finance, namely the likely need to register amendments or supplements to a large number of mortgages. The three largest flag states by tonnage are Panama, Liberia and the Marshall Islands. Their laws and practice in relation to mortgage registration are each, in different ways, prescriptive in relation to the description and recording of the obligations secured by the mortgage. The issue potentially arises in relation to the laws of certain other flag states, such as Greece, but the ‘big three’ registers have the most impact in practice.

"A more hardwired approach in documents now might reduce the perceived need for a supplement or addendum to the mortgage if and when transition away from LIBOR occurs."

It is likely that mortgagees will take a cautious approach to ensuring that they continue to be fully secured in the context of a new method of determining the reference rate of interest. This points to the need to record supplements or addenda to potentially thousands of existing mortgages. This issue is also relevant to new loans being documented. For new loans, whether there is a need to register a supplement or addendum to a mortgage upon transition to a new benchmark will depend on an analysis of the law of the relevant flag state and also the way that the transition away from LIBOR is documented. A more hardwired approach in documents now might reduce the perceived need for a supplement or addendum to the mortgage if and when transition away from LIBOR occurs.

This is an additional documentary burden and headache for the shipping industry specifically in circumstances where it faces the same challenges presented by LIBOR transition generally as all other industries. It could potentially be avoided by a change of law of the relevant flag states.

Conclusion

It is to be hoped that the way ahead will become clearer before too long so that, as regards both new shipping loans and existing deals, documentary issues can be addressed in a timely and orderly fashion. We will be keeping you informed, both by specific advice and through more articles, as further developments arise.

See also our more general article on LIBOR replacement here.

Glossary

APLMAThe Asia Pacific Loan Market Association, a trade association representing the participants in the syndicated loan markets of the Asia-Pacific region.
ARRCThe Alternative Reference Rate Committee which was set up in the US to find an alternative to US$ LIBOR.
IBAICE Benchmark Association Limited, the benchmark administrator for LIBOR.
Hardwired ApproachIncluding in an agreement a switch mechanism from LIBOR to an RFR, either completely, as contemplated in the LMA Rate Switch Agreement or simply the headline rates, leaving the details to be added via amendment at a later date, as per the ARRC drafting.
FMLCThe Financial Markets Law Committee, a London group drawn from market participants and law firms, which reviews financial law.
LMAThe Loan Market Association, a trade group which exists to enhance the development and running of the primary and secondary syndicated loan markets in Europe, the Middle East and Africa.
LMA Exposure DraftsA series of draft agreements offering either day one RFR interest rate calculation or a hardwired switch from LIBOR to RFR, in each case produced by the LMA to encourage the establishment of a market approach to offering and documenting RFR facilities. They are not recommended forms and leave a number of significant commercial issues to be agreed by the parties.
LMA Replacement Benchmark wordingOriginally published in 2018 and recently supplemented by two further suggested additions, this provides a framework for syndicated facilities to be amended.
LMA Rate Switch AgreementThe most recently published LMA Exposure Draft – a multicurrency facility which provides for benchmarks to switch away from LIBOR.
LSTAThe Loan Syndications and Trading Association, a trade group which exists to enhance the development and running of the North American syndicated loan market.
RFRRisk free rate, named as such because they are based on real transactions and therefore considered less vulnerable to manipulation. All those under consideration as the replacement benchmarks for LIBOR are overnight rates.
SOFRSecured Overnight Financing Rate. As the name suggests, unlike LIBOR, it is based on secured as opposed to unsecured transactions, namely the cost of borrowing cash overnight collateralised by Treasury securities, (admin: The Federal Reserve Bank of New York)
SONIASterling Overnight Index Average based on unsecured borrowing costs in the wholesale market (ie) interest banks pay to other financial institutions (admin: Bank of England).

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