LMA publishes RFR installation documentation
On January 28, 2021, the UK Loan Market Association (LMA) issued exposure drafts of two multi-currency term and revolving credit agreements that incorporate, among other things, retrospective compound risk-free rates (the Exposure drafts). In addition, the LMA has published commentaries on Exposure Drafts, which are intended to help market participants understand the terms of the Exposure Drafts. Exposure Drafts are based on the AML Exposure Draft Conversion Rate Agreements discussed in our previous blog post. The LMA hopes that their publication will facilitate awareness of the challenges of structuring multi-currency syndicated loans using retrospective compound risk-free rates (RFR).
Exposure drafts say from the outset:
- Compound RFRs will be used as the basis for calculating interest for amounts in US Dollars, Pounds Sterling and Swiss Francs. Parties should ensure that they are operationally capable of entering into and managing such a structure.
- Since EURIBOR will continue beyond the end of 2021, EURIBOR will be used as the basis for calculating interest for loans denominated in euros. The parties have the option of providing for the automatic replacement of the EURIBOR by the compound € STR at a later date.
Although one of the exposure drafts is based on a change of observation and the other is without a change of observation, they are identical except for the calculation provisions set out in Schedules 14 and 15. These schedules reflect the differences in the calculation formulas for a retrospection without a change of case and a retrospective with a change of case, the main differences being the weight of the daily RFRs in the formula and how this weight is used to treat the days non-working.
Market participants should note that Exposure Drafts apply SONIA’s loan market covenants as recommended by the Pound Sterling Risk-Free Benchmark Working Group (the SONIA conventions) and should therefore consider whether the SONIA conventions can be used in each specific transaction and for each relevant currency other than sterling. In particular, market participants should note that Exposure Drafts do not reflect conventions recommended by the United States Alternative Reference Rates Committee (the ARRC Conventions) for SOFR, which we discussed in our previous blog post. While there are some similarities between SONIA conventions and ARRC conventions, there are also a number of differences. Parties are able to tailor exposure drafts so that the appropriate approach can be specified for each relevant currency.
The publication of exposure drafts is a welcome step in efforts to transition to the use of RFRs in lending products. However, it is imperative that different market participants carefully consider exposure drafts in the context of each specific transaction and form their own opinion on the extent to which they are suitable as a basis for preparing loan documentation. This is all the more important since exposure drafts are based on SONIA conventions, which may differ in some respects from conventions for other currencies.