For several decades, IBORs have been used as a reference rate to determine interest and other amounts payable under a significant proportion of financing transactions. Following announcements in 2017 by the regulator of LIBOR that it would no longer support LIBOR after 2021, the transition away from IBORs has become a top priority for many financial institutions in the GCC and beyond. US$ LIBOR is a particular focus in the GCC context, given that many financing transactions are denominated in US dollars. In this note, we look at the current timeframe for IBOR discontinuation, as well as market trends and documentary options. We also touch on the status of IBORs in local GCC jurisdictions.

This note focuses on IBOR transition in the loan markets. Whilst also facing the impact of IBOR transition, other financing markets (such as the derivatives and debt capital markets) are at different stages and, in some cases, are taking slightly different approaches.

And, whilst IBOR is predominately used in financing agreements, we also come across commercial contracts referencing IBORs (for example, default interest clauses). Whilst references to IBORs in these contracts often do not go to the heart of such commercial contracts, they may on occasion. As a result, the tentacles of IBOR transition are likely to spread well beyond the financial markets, so in-house commercial lawyers are advised to start reviewing their exposure to IBORs if they have not yet done so.

Will LIBOR definitely disappear at the end of 2021?

No, at least in the case of US$ LIBOR. Until very recently, 31 December 2021 has been the key LIBOR discontinuation date for all LIBOR currencies. In anticipation of this date, there have been recommendations (by the Alternative Reference Rate Committee in the US and the Financial Stability Board in the UK) that firms should stop using LIBOR on new transactions from mid-2021. Regulators have repeatedly emphasised that the market should not assume that LIBOR will still exist after 2021.

However, at the end of November 2020, the administrator of LIBOR (ICE Benchmark Administration Limited) announced that it was consulting on continuing to publish the key US$ LIBOR tenors (overnight and one, three, six and 12 months) until 30 June 2023. We expect that any such extension will be accompanied by restrictions on using US$ LIBOR on new transactions after the end of 2021, so that the extension period can be used to embed alternative pricing mechanisms in the US$ market and reduce legacy US$ LIBOR books. The intention here is to allow affected parties to refinance their short-term LIBOR exposures at their maturity in order to ensure an orderly transition is maintained. The consultation is due to close at the end of January 2021.

Approaches to loan documentation

In the last few years, market participants entering into new IBOR-based loans with a tenor beyond 2021 have done so in the knowledge that IBOR may well disappear during the term of the loan. Different banks still have significantly different documentary preferences, and the LMA is in a market consultation phase with its recommended forms still being IBOR- rather than RFR-based. Broadly, four approaches to addressing the transition risk have emerged so far in the market:

1. The Amendment (Reduced Consent) Approach. The parties rely on their ability to amend the pricing terms as needed at the relevant time. To facilitate this approach, the LMA has published a revised "Replacement of Screen Rate" clause. This provides for the reduction of the lender approval threshold (from unanimous to majority consent) required for the relevant amendments to the facility agreement in the event of actual or likely imminent discontinuation of a relevant IBOR.

The relevant amendments to the loan terms would provide for interest to be calculated by reference to an RFR-based rate (or other benchmark acceptable to the relevant regulator). Although few legacy IBOR loans have been amended to date, most banks with significant legacy IBOR books are actively planning to adopt this approach, by undertaking major "bulk" repapering projects.

2. The Amendment (Compulsory Negotiation) Approach. This is based on the Amendment (Reduced Consent) Approach set out above, but (in addition) the LMA has also added an option to include an obligation to renegotiate if IBOR is still being used to calculate interest under the financing at a specified date. However, whilst we have seen this occasionally, we have not seen it very frequently in GCC deals and we are aware of a number of regional banks that expressly instruct us not to include this provision.
3. Hard-Wired Switch. This is a mechanism to automatically switch from IBOR to an economically equivalent RFR-based rate at a specified future date before the end of 2021. Early high-profile switch transactions included British American Tobacco's March 2020 multicurrency revolving credit facility. These are now common in the UK loan market and the LMA has published exposure draft multicurrency facility agreements incorporating a switch mechanism.
4. Hard-Wired Fallback. This is a mechanism to switch from IBOR to an economically equivalent RFR-based rate if an event occurs connected to the discontinuation or other unavailability of IBOR. This is similar to a Hard-Wired Switch, but without an automatic move away from IBOR on a specified date. In the EMEA loan markets, there has been limited adoption of this approach.

To what extent have the GCC loan markets transitioned away from IBOR on new transactions?

The transition away from IBOR (and towards rates based on overnight, virtually risk-free rates or "RFRs") has been much slower in the loan markets than in other markets that have traditionally used IBOR, such as derivatives and bonds. Progress during 2020 was undoubtedly hindered by disruption related to COVID-19.

Whereas in the UK market, RFR, hard-wired switch and hard-wired fallback facilities are now becoming much more common, our experience is that, for loans in currencies other than sterling, IBOR remains very much the default option, in most cases without an alternative mechanism for rate calculation.

Who will instigate the amendment of legacy IBOR loan agreements?

We anticipate that lenders will generally instigate this process, on both bilateral and syndicated transactions. On syndicated transactions, a lender wishing to start an amendment process would first need to put forward a proposal to the agent, and ask it to circulate this among the syndicate for discussion and agreement, before any proposal is put to the borrower.

What happens if legacy IBOR loans are not transitioned by the relevant discontinuation date?

Lenders would rely on the existing fallbacks in the facility agreement. Under typical fallbacks, following a permanent discontinuation of IBOR, the rate of interest is likely to be each lender's own cost of funds plus the margin (instead of IBOR plus the margin). This is clearly unattractive for a borrower. On a syndicated facility agreement, it is also unattractive for an agent, who will have to calculate different interest rates for different lenders. As such, this is unlikely to be a viable long-term solution.

What is the impact on Islamic finance transactions?

Islamic finance is an important and substantial part of the GCC finance market. It too will be impacted by IBOR discontinuation, but in a significantly more profound manner. Islamic finance, at its core, relies on certainty of payment obligations at the time the payment obligations are agreed. The backward-looking RFRs pose a much greater challenge to the Islamic finance than to the conventional loan markets. Whilst there has been some discussions around forward-looking RFRs, which the Islamic finance market could look to, regulators have been reluctant to prioritise or promote this for fear of allowing the conventional loan markets to benefit, as well as the general view that this would effectively inherit a number of features that were the very essence as to why regulators wanted to transition away from IBOR in the first place.

What is the status of local IBORs in the GCC?

There do not currently seem to be any plans to discontinue the main local IBORs used in the GCC markets for financing transactions denominated in local currencies – EIBOR, SAIBOR, OMIBOR and QIBOR, and these will continue to be published for the foreseeable future. However, as the underlying currencies to which these local GCC benchmarks apply are pegged to US dollars, the discontinuation of US$ LIBOR may still have an impact on their ongoing use.

Lenders in the GCC have been working to update their operating systems, financial modelling and documentation so as to be in a position to transition their loans as necessary when the time comes. For some, the possible extension of key US$ LIBOR tenors until mid-2023 may provide a welcome reprieve. In the meantime, the use of RFRs in the loan markets is not yet sufficiently settled for the LMA to issue standard provisions, and different banks continue to maintain different documentary preferences.