The $12 Trillion Syndicated Struggle: Why The Syndicated Loan Market is Slow to Leave LIBOR
It’s been slow going for the financial industry to transition away from the London Interbank Offered Rate (LIBOR), which regulators have said will be unavailable (or even invalid) after December 31, 2021. With less than two years before that deadline, the speed of progress has been inconsistent across debt asset classes. Case in point: the syndicated loan market. Why is this asset class, in particular, dragging its feet?
21 February 2020
As global financial markets try to dig out of the hole that is LIBOR, certain areas are progressing better than others: bigger banks (versus small lenders), European markets (versus those in Asia-Pacific), and even some debt asset classes (versus others). For example, bonds are further ahead of the LIBOR curve than syndicated loans. Bond markets have issued USD150+ billion bonds using alternative reference rates (ARRs; i.e., non-LIBOR) over the past two years; meanwhile, the syndicated loan market issued its first deal using the Secured Overnight Financing Rate (SOFR), the recommended ARR, only two months ago.
Why are syndicated loans lagging far behind bonds on LIBOR transition?
- Single versus multiple currencies: Bond deals are typically based on only one currency, whereas syndicated loans can incorporate multiple currencies. At least 300 multi-currency syndicated loan deals occur every year. LIBOR can accommodate many currencies, while the ARRs that are set to replace LIBOR are only single-currency benchmarks. This could complicate syndicated loans and cause pricing errors post- the LIBOR deadline.
- Backward versus forward-looking: For bonds – funds are fully distributed at the beginning of the lending period. Syndicated loans, on the other hand, allow borrowers to move in and out of the loan and vary the amount they need – whether for cash flow, capital expenditures, investments and/or acquisitions. As such, these loans ideally are pegged to a forward-looking, variable-rate benchmark (i.e., LIBOR) versus an ARR that would be based on daily averages. However, regulators have said that SOFR is risk-free, and therefore is not expected to behave similarly to LIBOR when markets are volatile.
What are syndicated loan participants/authorities doing to move past LIBOR?
Regulatory guidance: There is hardly a lack of recommendations and guidance from regulators around the world:
- Europe’s Loan Market Association (LMA) is proposing modifications to loan documentation to simplify the LIBOR-to-risk-free rates (RFRs) transition for existing loans. LMA is also issuing exposure draft version of direction on new structures and provisions for referencing new benchmark rates.
- Both the LMA and the Loan Syndications & Trading Association (LSTA) are working with US lenders to create methodologies and estimates.
- The International Swaps & Derivatives Association (ISDA) is providing LIBOR fallback calculations and publish compounded risk-free rates (RFRs)
- The Alternative Reference Rates Committee (ARRC) in the U.S. has published recommended fallback language to be included in syndicated loan contracts at origination, or in an amendment before LIBOR expires. ARRC also published the extensive Practical Implementation Checklist for SOFR Adoption.
Sharing lessons learned: The first syndicated loan deal using SOFR occurred in December 2019 with Royal Dutch Shell signing a USD 10 billion credit agreement with 25 lenders. Shell has said it is considering releasing the technical terms of the deal to help the market transition from LIBOR to SOFR. The terms are reportedly based on LMA’s exposure draft for SOFR.
So, what should banks, lenders and participants in the syndicated loan market be doing? At this point – in the absence of legislation or hard mandates by regulators – banks and lenders need to take it upon themselves to (1) stop using LIBOR for new loans and debt, and (2) get to work on reviewing existing loan contracts, assessing and taking any necessary action (incorporating fallback language, revising the contract to indicate an ARR or RFR, etc.) and mitigating against the risk that loan contracts become obsolete once LIBOR expires.
The magnitude of this work cannot be overstated. We recently wrote a white paper titled How to Update $400 Trillion in Loan Contracts for LIBOR Transition that details specific steps and best practices around managing the massive volume of documents and ensuring all loan contracts are in order by December 2021. I invite you to read it here and contact our sales team for more information on how Intralinks can help facilitate your organization’s LIBOR transition at scale.
Dominic Brown is a field technology head at Intralinks in Waltham, MA. Dominic employs his 15 years of compliance and IT experience, along with Intralinks’ unique technology, to help organizations address challenges with sharing, distributing, and collecting highly confidential data. Dominic helps organizations understand and change internal procedures to deploy technology solutions that dramatically reduce the risk and expense associated with secure data exchanges. He has spent his career working with the Fortune 1,000 and North America’s largest government agencies.