FINTECH 2021: FROM CRISIS TO CONSOLIDATION

For most people, life and work have changed fundamentally since the Covid-19 crisis began – and there are concerns that the crisis could still worsen again. Most areas of the world’s economy have been profoundly affected too, and the Fintech sector is no exception. Fintech has been both an epicentre of the crisis – and has also been central to recovery efforts, as payments have moved online and governments have sought to disburse financial support efficiently.

Our global Fintech team looks ahead to what 2021 holds for the sector, including fundraising, partnerships, M&A, and regulatory developments.

Access the full publication here.

 

Lenders potentially face a tsunami of complaints

Background of the loan repayment deferrals

On 20 March 2020, the Australian Banking Association (ABA) announced that banks were allowing the deferral of repayments for small business loans and mortgages for up to six months in order to assist Australians who were suffering financial hardship due to the effects of COVID-19.[1]

APRA reported that, as at 30 June, $274 billion worth of loans were subject to repayment deferrals, which constitutes almost 10% of the total outstanding loans.[2]  $195 billion of housing loans were deferred (being 11% of total housing loans) and $55 billion of small business loans were deferred (being 17% of total small business loans).

On 8 July 2020, the ABA announced the second phase, commencing at the end of the six-month deferral period. Where customers are able to restart loan repayments, they will be required to do so. If a customer can demonstrate reduced income or ongoing financial hardship, they may be eligible for an additional deferral of up to four months.[3]

Data from the Commonwealth Bank of Australia (CBA) indicates that a number of loans may still require the additional assistance from lenders because:

  • 12% of deferred loans are among those in “higher risk” occupations (such as retail, hospitality and airline staff);
  • 84% of loans were for the principal and interest amount (with APRA reporting that around 8% of housing loans have a loan to value ratio of greater than 90%); and
  • 14% of deferred home loans involved at least one borrower receiving JobSeeker, and around 30% of deferred business loans were made by borrowers receiving JobKeeper.[4]

Accordingly, it is expected that a notable proportion of deferred loan recipients will continue to be in financial hardship after the expiry of the six month deferral period.

 

ASIC and APRA’s guidance on loan deferrals

On 13 August 2020, ASIC released guidance reminding retail lenders of its expectations when transitioning out of the current phase of the deferral scheme.[5] This is an expansion on prior guidance released by ASIC on 29 April 2020 and updated on 9 June 2020.[6]

The guidance relates to lenders’ obligations (which include non-bank credit providers) under section 72 of the National Credit Code, whereby a lender must consider varying a consumer’s credit contract if a consumer notifies them that they are or will be unable to meet their credit obligations. In addition, lenders must also do all things necessary to ensure that the credit activities authorised by their licence are engaged in efficiently, honestly and fairly.

When COVID-19 initially began, ASIC’s expectations focused on customers going into hardship, articulating the following expectations:

  1. Communicate with consumers about the different options that may assist them, depending on their circumstances.
  2. Be flexible and offer tailored solutions to consumers where a standardised ‘one-size-fits-all’ approach may not meet a particular consumer need. For example, if a consumer has had their loan repayments deferred, a lender should ensure that how a consumer will catch up on missed repayments is manageable and offer alternatives.
  3. Ensure all communications with consumers are clear and provide consumers with sufficient information to make an informed decision about the assistance available. This should include details of how different assistance options will affect the consumer’s loan and repayments over the short and long term, including the effect of capitalising interest (where relevant).
  4. Have ongoing communications with consumers throughout the period of assistance to ensure that any assistance offered remains appropriate and continues to meet their needs.
  5. Communicate with consumers as their period of assistance comes to an end to understand their financial circumstances at that time, respond as appropriate and ensure each consumer understands what will happen next.

Now that loan deferrals could be reaching an end, expectations 2 and 5 have been further enhanced with ASIC articulating what a process that delivers “appropriate and fair outcomes” includes.  While stating that lenders should have in place processes that are easy for consumers to understand and navigate, ASIC has made the following detailed guidance:

Stage of process ASIC’s expectations
Contacting consumers about the expiry of the deferral period ·       Lenders should make reasonable efforts to contact consumers before their loan deferral expires.

·       Consumers should have reasonable time to consider their options.

·       Lenders should provide consumers with information that would assist in their decision making. On this, ASIC considers that more can be done by lenders to provide consumers with personalised information or representative examples about how assistance arrangements may affect their repayments and the cost of their loan over the longer-term.

·       If a consumer cannot be contacted, lenders should attempt a range of communication channels and should be able to evidence that they have made reasonable attempts to do so.

Where a consumer cannot resume full repayments ·       Lenders must make reasonable efforts to have a direct interaction (such as a phone call) to allow lenders to gather more personalised information about the consumer’s circumstances to make a decision about the consumer’s loan in a fair and appropriate manner.
Deciding to offer further assistance ·       If lenders decide that it would be appropriate to offer further assistance, the process should be flexible and the assistance offered should be tailored to genuinely address the consumer’s needs.

·       Records should be kept setting out the assistance options provided to each consumer.

Deciding not to offer further assistance ·       In situations where a consumer’s financial difficulties are so severe that they will not be able to repay their loan over the longer-term, ASIC expects lenders to make all reasonable efforts to work with consumers to keep them in their homes if that is in their best interests. On this, ASIC recognises that there will likely be some circumstances where offering a consumer further temporary assistance may make their situation worse. Such situations will need to be carefully identified by lenders and involve a high level of engagement with those affected consumers.

·       Lenders must notify consumers of their right to complain to the Australian Financial Complaints Authority

Where loan repayments are missed ·       If a consumer’s deferral expires and a subsequent repayment is missed, lenders should make reasonable efforts to contact them and assess the appropriateness of further assistance being offered to them.

 

On the same date, APRA announced that it was accepting feedback on a proposal to formalise temporary changes to capital treatment and reporting requirements for deferred loans through legislative instruments. APRA proposes to add an attachment to APS 220 Credit Quality to accommodate this.[7]

 

Additional ASIC reminders

In the guidance, ASIC provided some reminders for lenders, namely:

  • if a consumer is dissatisfied with a lender’s response or actions, lenders must ensure that they comply with the requirements set out in ASIC’s Regulatory Guide 165: Internal and external dispute resolution and the newly released Regulatory Guide 271: Internal dispute resolution, coming into effect in October 2021; and
  • responsible lending obligations should not be considered by lenders as a barrier to making appropriate changes to the terms of existing loans in response to hardship situations;

 

Consequences for lenders – complaints

There are many practical consequences of the above for lenders and this note focusses on one in particular. It is widely anticipated that the above approach will see a significant increase in the number of complaints being raised both with lenders (who may need to increase resources for their complaints handling function in order to meet their complaints handling commitments to consumers) and with complaints referred to AFCA.  It can be very time consuming for lenders in addressing complaints referred to AFCA and some market participants are concerned about the approach AFCA will take to these complaints when considered against their ‘fairness’ approach. In addition, some in the market are particularly concerned that AFCA may not take into account directions made by ASIC/APRA to lenders during this time.

 

[1] Australian Banking Association, ‘Banks announce Small Business Relief Package’, 20 March 2020, https://www.ausbanking.org.au/banks-small-business-relief-package/.

[2] Australian Prudential Regulation Authority, ‘Temporary loan repayment deferrals due to COVID-19, June 2020’, 4 August 2020, https://www.apra.gov.au/temporary-loan-repayment-deferrals-due-to-covid-19-june-2020.

[3] Australian Banking Association, ‘Banks enter phase two on COVID-19 deferred loans’, 8 July 2020, https://www.ausbanking.org.au/banks-enter-phase-two-on-covid-19-deferred-loans/.

[4] The ‘Distribution by risk score’ diagram is helpfully provided by CBA, and the ‘Housing loan risk profiles’ diagram is provided by APRA. See William Jolly, ‘CBA full-year results: Loan deferrals falling, cash deposits rising’, 12 August 2020, https://www.savings.com.au/home-loans/cba-half-year-results-loan-deferrals-falling-cash-deposits-rising.

[5] ASIC, ‘COVID-19 and financial hardship: ASIC’s expectations of retail lenders when loan repayment deferrals end’, 13 August 2020, https://asic.gov.au/regulatory-resources/credit/covid-19-information-for-lenders/covid-19-and-financial-hardship-asic-s-expectations-of-retail-lenders-when-loan-repayment-deferrals-end/. See also ASIC’s media release, 20-184MR.

[6] ASIC, ‘COVID-19 and financial hardship: retail lenders’ obligations and ASIC’s expectations’, 29 April 2020 (updated 9 June 2020), https://asic.gov.au/about-asic/news-centre/news-items/covid-19-and-financial-hardship-retail-lenders-obligations-and-asic-s-expectations/.

[7] APRA, ‘Consultation on treatment of loans impacted by COVID-19’, 13 August 2020, https://www.apra.gov.au/consultation-on-treatment-of-loans-impacted-by-covid-19.

 

Charlotte Henry
Charlotte Henry
Partner
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Tony Coburn
Tony Coburn
Consultant
+61 2 9322 4976
Lesley Symons
Lesley Symons
Executive Counsel
+61 7 3258 6704

Impending changes to fee disclosure transitional provisions

ASIC has (again) flagged that it will be amending the transitional arrangements in the ASIC Corporations (Disclosure of Fees and Costs) Instrument 2019/1070 (Instrument) on its superannuation fund COVID-19 FAQ page:

ASIC will be amending the transitional arrangements for Product Disclosure Statements (PDSs) shortly to allow entities to come into the new disclosure regime from 30 September 2020 and require any PDS given on or after 30 September 2022 to comply with the new disclosure regime. There will be no change to the periodic statement transition arrangements. ASIC will issue a media release and update the RG 97 webpage when the amendment is made.

The Instrument amends Schedule 10 to the Corporations Regulations, which sets out disclosure requirements for PDSs and periodic statements. ASIC had previously announced in late April that it was considering making this change, on its regulatory update on its website titled “Changes to regulatory work and priorities in response to COVID-19“.

Currently under the Instrument, all PDSs issued from 30 September 2020 must comply with the Instrument rather than ASIC’s Class Order CO 14/1252, which will no longer apply to such PDSs from that date. This proposed amendment will bring welcome relief to financial product issuers who are not yet ready to transition to the new requirements under the Instrument.

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411

Ruth Stringer
Ruth Stringer
Consultant
+61 2 9225 5099

FINANCIAL PRODUCT DISCLOSURE IN THE AGE OF COVID-19

By Michael Vrisakis, Tamanna Islam and Sky Kim

 

The way we live, work and socialise have not been the only changes owing to the COVID-19 pandemic – the Government has also been led to introduce a variety of measures affecting the financial services industry, including the reduction of default minimum withdrawal rates for pensions (for 2019-20 and 2020-21) and allowing for temporary early release of superannuation.

The economic impact caused by the pandemic also means that many sections in a product disclosure statement (PDS) may need to be updated, including significant risks, liquidity, distribution policy, asset allocations and valuations, underlying assumptions and fees and costs. This poses important questions for financial product issuers, who have ongoing obligations under the Corporations Act 2001 (Cth) (Corporations Act) to ensure that their PDSs are kept up to date and to notify holders of financial products of material changes and significant events.

Product issuers who are required to, or wish to, update their PDSs in a cost-effective and expeditious manner, are provided some useful practical relief under the ASIC Corporations (Updated Product Disclosure Statements) Instrument 2016/1055 (Instrument). An important regulatory marker to pay attention to is the key restriction on using the Instrument, namely that the updated information cannot be materially adverse. We explore this concept in further detail below as well as what types of changes need to be disclosed and what disclosure options might be available to product issuers, including if and when the Instrument could be relied upon. Greater flexibility exists, in our opinion, to add product changes and deal with COVID-related operational changes than might have been thought to be the case.

 

What types of changes need to be disclosed?

As a starting point, section 1012J of the Corporations Act provides that the information in a PDS must be up to date at the time it is given. A PDS must also not otherwise be “defective” under the Corporations Act.

Updated information may relate to any aspect of the PDS or the product, whether materially adverse or not. A supplementary product disclosure statement (SPDS) containing updated information may be given with a PDS that is out of date (other than in the case of a short-form PDS). Alternatively, the product issuer may issue a new PDS (ie a PDS roll), although this clearly has cost, time, operational and other logistical implications.

Any changes that impact the significant characteristics and features of a financial product, the rights, terms and conditions and obligations attaching to the product or any other information relevant to the acquisition decision must be disclosed via an update to the PDS to prevent the PDS from being out of date or defective.

It should be noted that it would not be necessary to update a PDS in relation to information which, as contemplated by section 1013F of the Corporations Act, is not required to be included in the PDS because it would not be reasonable for a retail client to expect to find this information in the PDS. An example might be the new superannuation access scheme which because of Government, media and regulatory publicity, may not be information that a retail client would reasonably expect to find in the PDS.

 

What can be disclosed without a SPDS or a new PDS?

A SPDS or a new PDS containing updated information may be used to prevent a PDS from becoming non-compliant on the basis of the PDS being outdated or defective. However, not all disclosures will require a SPDS or a new PDS, as the Instrument permits any updates that do not include “materially adverse” information may be disclosed elsewhere, subject to the following conditions being met:

  • The PDS was up to date at the time when it was prepared;
  • the updated information in relation to the PDS does not include any materially adverse information;
  • The issuer has taken reasonable steps to ensure that the PDS clearly and prominently explained that information that is not materially adverse information is subject to change from time to time and may be updated by means described in the PDS, explained how that updated information can be found out at any time, and stated that a paper copy of any updated information will be given, or an electronic copy made available, to a person without charge on request;
  • The issuer has taken reasonable steps to establish and maintain means by which a person may find out any updated information, being means that are simple and involve no charge and little inconvenience to the person, having regard to the kinds of persons likely to consider acquiring the financial product to which the PDS relates; and
  • The issuer has taken reasonable steps to make available any updated information as soon as practicable to each regulated person to whom the PDS has been provided for further distribution and to cause a copy of any updated information to be kept for 7 years after it is prepared.

The effect of the above is that even if the updated information would ordinarily require the issue of a new PDS or a SPDS, this would not be required as long as the information is not materially adverse to the holder, the issuer met the other conditions of the Instrument, including by establishing other simple means by which the holders can access any updated information (such as website disclosure).

From a practical perspective, it is important to remember that the Instrument may only be used for PDSs that become out of date. The Instrument relief cannot be used in respect of defective PDSs as any changes to correct a defective PDS would be materially adverse, as per the definition in section 1021B of the Corporations Act.

Therefore, there must be a change in order for the Instrument to be used. The Instrument is ideally suited to update a PDS for non-materially adverse COVID-19 changes instituted by the product issuer to the product itself or an associated administrative process. In addition, it can also be used for other changes affecting the information in the PDS which are not made by the product issuer, such as regulatory changes (including during COVID-19).

It is always important to bear in mind that the Instrument cannot be used in all cases of an out of date PDS. Where a PDS has become out of date by reason of a materially adverse change (ie the PDS becomes defective), the Instrument cannot be used because, as noted above, the information has become materially adverse and the central condition in the Instrument is therefore not satisfied.

 

What constitutes “materially adverse” information?

There are several ways in which additions to or other modifications to information contained in a PDS could be materially adverse. For example, adding restrictions to withdrawal criteria in superannuation, or increasing the frequency of indexation of fees would constitute materially adverse information. The concept of “materially adverse” information is defined in the Instrument as:

“information of a kind the inclusion of which in, or the omission of which from, a Statement would render the Statement defective within the meaning of section 1021B of the Act”.

This concept of “defective” is, in relation to a disclosure document or statement, defined as:

  1. there is a misleading or deceptive statement in the disclosure document or statement; or
  2. if it is a PDS — there is an omission from the PDS of material required by section 1013C, other than material required by section 1013B or 1013G (content requirements); or
  3. if it is a SPDS that is given for the purposes of section 1014E—there is an omission from the SPDS of material required by that section; or
  4. if it is information required by paragraph 1012G(3)(a)—there is an omission from the information of material required by that paragraph;

being a statement, or an omission, that is or would be materially adverse from the point of view of a reasonable person considering whether to proceed to acquire the financial product concerned.

 

The content requirements include that a PDS must contain information:

  • about the significant characteristics and features of the product, or of the rights, terms and conditions and obligations attaching to the product (section 1013D(1)(f) of the Corporations Act); and
  • that might reasonably be expected to have a material influence on the decision of a reasonable person, as a retail client about whether to acquire the product (section 1013E of the Corporations Act).

Importantly, the concept of “materially adverse” requires the information to be both material and adverse from the perspective of a reasonable person deciding whether to acquire the product. It is not enough that the information is merely “material”, as required under section 1013E of the Corporations Act.

 

What changes can the Instrument be used for?

A key issue relevant to relying on the Instrument to update the contents of a PDS, particularly in the current climate, is just exactly what type of content can be added to, varied or replaced in the PDS.

At first blush, this may seem a trite issue. The reality, however, is a little different. Section 1012J simply stipulates that the information in the PDS must be up to date as at the time it is given. This indicates that changes to any information which is in the current PDS must be updated in the PDS at the time it is given to the retail client. This contextualisation requires one to focus on the types of information which are included in the PDS.

The Corporations Act very clearly states that a PDS contains, or can contain, two categories of information, as follows:

  • statements and information required by the Corporations Act (ie Division 2 of Part 7.9). Information required to be included in the PDS fits into two sub-categories. The first is specific information required by section 1013D. The second is any other information which might be expected to have a material influence on the decision of a reasonable person, as a retail client about whether to acquire the financial product, as required by section 1013E; and
  • any other information which may be included in the PDS but which is not required.

Although differing legal views have been expressed, it remains our unequivocal view that by reason of section 1013C, the Instrument can be used not only to update information required by the Corporations Act (ie as referred to in section 1013C(1)(a)) but to update any other information that has been included voluntarily (ie as referred to in section 1013C(1)(b)).

The implications of this legal position are significant for product issuers who wish to rely on the Instrument to deal with COVID-19 related changes. This is because they will be able to rely on the Instrument to update information in the PDS:

  • where the product features or other information required by section 1013D changes such as information about:
    • fees and costs;
    • significant characteristics or features of the product or of the rights, terms and conditions and obligations attaching to the product; or
    • significant risks associated with the product,

subject to the materially adverse condition; and

  • any other changes to the information contained in the PDS. This is very broad, as it captures voluntary disclosure as flagged above.

The use of the word “update” suggests that the content is being changed which could mean additions, subtractions or modifications to the existing information in the PDS.

To understand how wide the use of the Instrument would be, it is useful to identify some practical examples:

  • Scenario 1: A superannuation trustee lowers the minimum investment amount for its superannuation product due to COVID-19

The trustee may rely on the Instrument and update this information via its website, as the information is unlikely to be materially adverse to a prospective member.

  • Scenario 2: A superannuation trustee issues pensions-based investment products and must disclose the reduction of default withdrawal rates for pensions by 50% for 2019-20 and 2020-21 as a result of COVID-19

The trustee will be able to successfully rely on the Instrument on the basis that the information update is unlikely to be materially adverse to prospective pensioners and instead, is a factual update of statutory changes.

  • Scenario 3: The responsible entity of a managed investment scheme must change its asset allocations disclosed in its PDS due to changed economic conditions as a result of COVID-19

It is likely that the responsible entity will need to make the change through an updated PDS or a SPDS, as the changing asset allocations may constitute materially adverse information.

  • Scenario 4: An insurer is increasing its fees and charges due to changed economic conditions as a result of COVID-19

The insurer will need to issue an updated PDS or a SPDS. This is because an increase in fees and charges is materially adverse information which means the Instrument will not apply.

  • Scenario 5: A superannuation trustee wishes to disclose additional withdrawal options available to members, such as introduction of financial hardship withdrawals during COVID-19

The trustee may rely on the Instrument and update this information via its website, as the information is unlikely to be materially adverse to a prospective member.

Beyond these specific examples, there are a range of disclosure situations in which the Instrument can be relied upon (which in addition to the specific examples above assume that the Instrument conditions are satisfied), such as:

  • Certain changes to product features: This could cover switching restrictions, withdrawal restrictions, changes to indexation and eligibility criteria;
  • Information relating to regulatory matters: This could cover changes to the way the product is legally regulated, for example, changes to legislated withdrawal amounts; and
  • Information relating to operational matters: This type of information will often fall into the reasonably expected information (see discussion on section 1013E above) or information voluntarily disclosed (see discussion relating to section 1013C(2) above). This can include matters such as:
    • application or redemption processes;
    • unit pricing methodology and asset valutions; or
    • hardship withdrawal requirements.

 

Significant Event Notices

Section 1017B of Corporations Act requires ongoing disclosure of material changes and significant events, as well as a significant event notice (SEN) where there is any material change to a matter or significant event that affects a matter that would have been required to be specified in a PDS for the financial product. This updating obligation does not apply to widely held managed investment schemes where 100 or more people hold units in a class where the offers of those units required a PDS (where the units are ‘ED securities’).

If the change is an increase in fees or charges, then the SEN must be issued 30 days before the change takes place. The SEN must include all information that is reasonably necessary for a product holder to understand the nature and effect of the event.

If the change is not an increase in fees or charges, then the SEN should be given before the change or event occurs or as soon as practicable after, but not more than 3 months after the change or event occurs. However in some cases the SEN may be given more than 3 months after the change or event occurs if the issuer reasonably believes that the event is not adverse to the holder’s interests and accordingly, the holder would not be expected to be concerned about the delay in receiving the information. In this case, the information must still be given within the period of 12 months after the change or event occurs. By relying on this provision, issuers can provide updates by other member communications such as annual reports, making it a more cost-effective option with less operational impact.

 

Misleading or deceptive conduct

A PDS is defective if it includes a misleading or deceptive statement that is materially adverse. The term “misleading” is defined at sections 12BA and 12BB of the ASIC Act as where:

  • a person has made a representation to a future matter (including the doing of an act); and
  • the person does not have reasonable grounds for making the representation (but the 12BB definition expressly states (at section 12BB(4)) that it does not limit what is meant by the term misleading.

 

The term “deceptive” is not defined under the ASIC Act or the Corporations Act.

In its paper, ‘The AFCA Approach to Misleading Conduct’, the Australian Financial Complaints Authority outlines misleading conduct as conduct that:

  • leads, or is likely to lead, someone into error or to believe something that is false;
  • can happen when a financial firm says something that is wrong, acts in a way that misleads a complainant or does not say or do something when it should; and
  • can occur even if the financial firm did not mean to mislead or the complainant could have found out the true position by looking into the matter further.

Therefore, it is important to ensure that despite the means by which the update is communicated to the product holders, any updates of the information contained in the PDS will not be rendered misleading as a result of the updated information.

This continues to be an area of regulatory focus by ASIC.

 

Pythia’s wisdom: The Instrument can be used to update for product changes initiated by the product issuer (provided not materially adverse), not just externally caused changes. So there is more flexibility than one might initially imagine.

Who is Pythia?

Pythia was job title given to the original Delphic Oracle. She represents a strong female voice in Ancient Greek times in the role of dispenser of wisdom and sage advice to the population of Delphi.

Our Pythia’s Wisdom feature is in part homage to Pythia, as although the term has not entered the English language day to day lexicon, the phrase “Delphic Oracle” has of course.

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160
Sky Kim
Sky Kim
Solicitor
+61 2 9225 5573

LIBOR transition: The risks of interim milestone delay for the cash market due to COVID-19

This article was originally published on Banking Litigation Notes.

The Working Group on Sterling Risk-Free Reference Rates (RFRWG) has published a further statement on the impact of COVID-19 for firms’ LIBOR transition plans.

The latest statement follows the earlier joint statement made by the FCA, Bank of England and RFRWG on 25 March 2020, in which the regulators set out their initial response to the impact of COVID-19 on transition plans.

In this blog post we consider the specific delays to interim LIBOR transition milestones that have been announced, the likely effect such delay is likely to have on loan market LIBOR transition and how this may impact the profile of the associated litigation risks.

 

Overarching theme of the regulators’ COVID-19 impact statements

Both of the statements published by the regulators/working group, emphasise that the deadline for LIBOR cessation remains fixed for end-2021 and firms cannot rely on LIBOR being published after that date, notwithstanding the impact of COVID-19 on firms’ steps to prepare for that event. The regulators are working with the RFRWG and its sub-groups and task forces to consider how all firms’ LIBOR transition plans may be impacted.

However, recognising the reality at least in the short term, it is clear that some interim transition milestones may be delayed. The most recent communication announces the first key date to be affected.

 

Delay to key interim milestone in the loan market

The first key interim LIBOR transition milestone to be affected by COVID-19 is the deadline by which the cash market is recommended to stop issuing LIBOR linked loans. That deadline was originally the end of Q3 2020 but has now been pushed back to the end of Q1 2021.

The RFRWG’s current timetable as to the use of LIBOR-linked loan products is now as follows:

  • By the end of Q3 2020 lenders should be in a position to offer non-LIBOR linked products to their customers;
  • After the end of Q3 2020 lenders, working with their borrowers, should include clear contractual arrangements in all new and re-financed LIBOR-referencing loan products to facilitate conversion ahead of end-2021, through pre-agreed conversion terms or an agreed process for renegotiation, to SONIA or other alternatives; and
  • All new issuance of sterling LIBOR-referencing loan products that expire after the end of 2021 should cease by the end of Q1 2021.

The regulators have repeatedly acknowledged that the loan market has made less progress in transitioning away from LIBOR than other markets. This led to various initiatives earlier this year to accelerate change, with an emphasis on steps to alleviate some of the difficulties which were faced in the cash markets: The Bank of England’s attempts to “turbo-charge” LIBOR transition in the cash markets: will these increase or decrease the litigation risks? In particular, the Bank of England announced the publication of a SONIA-linked index from July 2020 to support market participants to cease issuing LIBOR-based cash products (maturing beyond 2021). It is therefore perhaps not surprising that the first interim milestone to be relaxed is in that market.

 

Impact on loan market LIBOR transition 

Given that one of the most important drivers to move the cash market to new risk free rates (RFRs) is to stop writing new loans linked to LIBOR, the RFRWG’s decision to delay this particular milestone is significant, though not surprising given the pressures that both lenders and corporates find themselves under as a result of COVID-19.

While there was significant impetus from both lenders and corporates behind a movement to RFRs in the loan markets in Q1 of 2020 (for example British American Tobacco signed a USD 6bn revolving credit facility linked to both SONIA and SOFR in March – see this press release), which will be further boosted by the publication of central bank indices, there has been an understandable hiatus as the impact of COVID-19 has been felt. The issues around market conventions for compounding, and the development of new loan and treasury management systems to support RFR loans, have not yet been resolved, nor has the calculation been fully settled of the credit spread above the RFRs to ensure that the transfer is value neutral. Once the immediate impact of COVID-19 has abated, attention will need to be turned to these once again.

During the extension period (i.e. the six-month period from the original deadline of end-Q3 2020 to end-Q1 2021), the RFRWG’s guidelines state that all new and re-financed LIBOR-linked loans should include a robust fallback mechanisms to enable transition to SONIA (or other alternatives) when LIBOR ceases. For example, through pre-agreed conversion terms or an agreed process for renegotiation.

 

Profile of litigation risks: impact of delay

Most loans currently being issued include more robust fallbacks of the kind envisaged by the RFRWG’s guidelines (i.e. including an agreed process for renegotiation when LIBOR ceases). However – importantly – the deadline relaxation will mean a further six months’ worth of facilities being written in LIBOR, which will increase the overall volume of LIBOR-linked loans in the market when the benchmark ceases.

The particular risks associated with fallbacks based on a requirement to renegotiate at the time of LIBOR cessation fall broadly within two categories:

  1. Commercial difficulties. An agreed process for renegotiation will only take participants so far: each transaction will still need to be amended on a deal-by-deal basis, though the LMA hopes that its exposure draft form of reference rate selection agreement will smooth this process in some cases. Accordingly, the way in which negotiations unfold on a loan by loan basis will reflect the relative bargaining strengths of the parties at that time.
  2. Practical difficulties. Continuing to increase the volume of loans which will subsequently require renegotiation upon the cessation of LIBOR (on top of legacy loans) will increase the practical challenges firms will face, and the time and cost burden, particularly for those with large books of bilateral loan facilities.

In summary, while pushing this interim milestone back by six months may provide some welcome breathing space in the cash market in the short term, it is not without cost. It will almost certainly increase the challenges firms face in the next stage of the process to achieve LIBOR transition in this market by the fixed deadline of end-2021. It is unlikely that this is the last adjustment to that timetable which will need to be made.

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Fiona Smedley
Fiona Smedley
Partner
+61 2 9225 5828
Charlotte Henry
Charlotte Henry
Partner
+61 2 9322 4444
Harry Edwards
Harry Edwards
Partner
+61 3 9288 1821