Last September, the LMA published Exposure Drafts of Compounded RFR Facilities Agreements by reference to SOFR and SONIA (being the chosen replacement near risk free rates for USD markets and LIBOR in the Sterling respectively), along with a commentary inviting market participants to consider various structuring issues (see earlier blog).
The APLMA recently sought feedback from its members on the key structuring issues arising from the LMA Exposure Drafts. Here is a summary of the responses.
A majority of respondents preferred:
- a compounded (SOFR) rate(56%) rather than the simple average approach (44%);
- consistency in the calculation methodology for compounded rates across currencies and products and most are of the view that the compounded rate should apply to all days in a given period including weekends and public holidays;
- a screen rate of the compounded average rate to be published by a reputable information service and an impediment that the calculation methodology be transparent;
- an independent calculation agent (54%) as opposed to the Agent Bank (43%) undertake the calculation of the compounded average rate;
- another finance party be obliged to take on the role of calculating the fallback compounded rate as opposed to it being ‘optional’;
- a 5-day lag period and advocated for consistency so as to synchronise borrowings with hedging arrangements;
- consistency of approach, methodology and calculation across currencies and jurisdictions and between derivative and cash products in terms of credit adjustment spread, to streamline the transition; and
- in terms of market conventions (swaps and loan market),(unanimity) that the basis risk between the hedging market and the loan market should be minimised as much as possible.
There were varied views on:
- whether the fallbacks should first be to central bank rates with a spread adjustment included and then to cost of funds as a final fallback or an immediate fallback to cost of funds;
- interest rate structure -there is some reluctance to include the credit adjustment in the margin and comment that adjustment of the margin will prove difficult for legacy deals which need to be transitioned to RFRs;
- the relevance of break costs when interest rates are derived from RFRs. Some comment that lenders should be compensated for market changes and that they should have the contractual right to notify a borrower of market disruption and/or break costs within a set period of time following the end of the interest period; and
- who should bear amendment costs.
It is encouraging to see the APLMA actively engaging market participants in Asia Pacific. Such engagement is crucial as an impetus to the transition process in the region as we approach the deadline of end-2021, if not possibly earlier. It facilitates awareness and provides invaluable insight from market participants as stakeholders progress on the key structuring and operational issues, inherent in the development of what is effectively a new credit product.
The APLMA survey can be found here.