The history of manipulation and scandals surrounding interbank offered rates (IBORs), for example LIBOR and JIBAR, has led to the shift toward Risk-Free Rates (RFRs), a shift which is primarily market led and remains uncertain.
The transition to RFR’s rests on the fact that rates such as LIBOR are forward-looking interest rates, calculated using estimates and expert opinions. RFRs are predominantly backward-looking, near risk-free rates calculated on preceding data and are published daily. The move toward RFRs will require significant changes to loan agreements on a transaction-by-transaction basis – given the multidimensional nature of syndicated loans – a time-consuming and complicated process.
The Loan Market Association (LMA) has published a draft exposure document, the Reference Rate Selection Agreement (the RRSA), which aims to simplify the transition toward RFRs by guiding the parties’ conversion of an interest rate funding agreement based on LIBOR into a funding agreement applying RFRs.
The draft agreement provides a method for selecting an applicable interest rate by setting out the basic commercial terms on which parties can agree to an alternative benchmark rate that will be used to calculate interest in place of LIBOR. In this way, the RRSA affords parties a consistent approach to amending each facility agreement in the transition to an alternative interest rate.
There are various approaches that the parties can take in applying a new interest rate:
- The first is a two-stage process which incorporates agreed upon changes using the RRSA and an amendment agreement. This process is managed by the agent and the obligors without needing all parties’ approval of each amendment.
- The parties may agree that the changes as per the RRSA are deemed to be made to the underlying facility agreement.
- The parties can elect not to use the RRSA at all and rather enter into a single amendment agreement which includes all agreed upon changes. This requires each party to the facility agreement to approve each amendment, a burden that the RRSA seeks to alleviate.
The RRSA can be read together with the draft exposure documents released by the LMA in September, which suggest possible alternative risk-free rates for the sterling and US Dollar. Both of these exposure documents as well as the RRSA are published as suggested guides and are open for comment from market participants.