On 7 August 2019, the Loan Markets Association (LMA) published a guidance note highlighting considerations in respect of the application of credit adjustment spreads in the context of the move from LIBOR to near risk-free rates.
The LMA Revised Replacement of Screen Rate clause can operate at cessation of LIBOR or pre-cessation (for instance if majority lenders determine the screen rate is no longer appropriate) and the LMA note that careful consideration is required as to whether the same methodology is appropriate for each. In both cases, the clause contemplates that amendments include a pricing adjustment to reduce or eliminate any transfer of economic value as a result of a replacement benchmark.
The LMA note the below as two of the possible methods which could be considered, noting that whilst the first might be appropriate for fallbacks triggered on cessation of LIBOR, it might not be considered appropriate for either active transition to Risk Free Rates (RFRs), or for fallbacks triggered, prior to the cessation of LIBOR.
- The method currently being considered by the International Swaps and Derivatives Association (ISDA) for fallbacks, where a historic average is taken between LIBOR and SONIA.
- The method used by Associated British Ports on their successful bond amendment consent solicitation, where the forward market is used.
We view this as a positive step towards aligning the approach across products, something we've been calling for from the start.
Additionally last week ISDA published preliminary results of the pre-cessation consultation for derivatives showing mixed views and no clear majority for any category (for or against a pre-cessation trigger / hardwired or not). Concerns over product mis-match continue.
Like ISDA, the currency working groups in the UK and US are also contemplating consultations in respect of the credit adjustment spread methodologies for cash markets. The LMA are naturally encouraging loan market participants to respond to these consultations when launched.