In May 2020, the Tough Legacy Taskforce (the Taskforce) of the Working Group on Sterling Risk-Free Reference Rates (the RFRWG) published a paper entitled "Statement on the identification of 'tough legacy' contracts across asset classes" (the Statement)1; making a case for action in relation to tough legacy contracts (i.e., those in which the transition away from LIBOR is particularly difficult using market solutions) across a number of different asset classes.
While highlighting the increasingly urgent need for action (a need that has been heightened by the shift of focus and resources away from LIBOR transition as a result of the COVID-19 pandemic), the Taskforce has set out the key considerations on tough legacy contracts and recommendations for market participants.
These considerations provide useful guidance to market participants in assessing the nature of their exposure to tough legacy contracts. The Taskforce also expresses a preference for the UK Government to adopt a legislative solution to the tough legacy problem.
The Taskforce cautions that its preferred legislative solution may not materialise, and recommends that other solutions be pursued in parallel. In addition, even if a legislative solution were to be implemented, that solution may not serve market participants as well as amending their own contracts. The RFRWG's overall view remains that market participants should proactively address the transition away from LIBOR in their contracts before the end of 2021 (the date on which LIBOR is expected to be discontinued).
The Statement notes that any legislative solution may have unintended or undesirable consequences, including that such a solution may not be economically neutral. The Taskforce recommends that market participants should only rely on a legislative solution (assuming one is in fact enacted) for contracts that are 'genuinely stranded'.
In the absence of legislative or other external solutions to the difficulties that may arise as a result of the discontinuation of LIBOR, parties should review all contracts for potential impact resulting from the discontinuation of LIBOR and, whenever possible, amend contracts to refer to an alternative rate or to introduce fallbacks enabling conversion to an alternative rate.
Market participants should:
- proactively identify contracts that may be tough legacy contracts even before specific legislative and regulatory guidance on how to deal with them is made available;
- consider how to address barriers to active transition in respect of any contracts that are identified in order to reduce the number of actual tough legacy contracts;
- keep up-to-date with any developments in relation to LIBOR transition and consider potential workable alternatives (even if these do not include a compounded risk free rate) along with identifying the ideal timeframe in which to implement these;
- engage in active transition away from LIBOR to the extent possible (on the basis that it is the approach offering the highest degree of control over the terms of such a transition); and
- make it as easy as possible to amend contracts, for instance by reducing consent levels or agreeing to 'protocol' style approaches where the same parties need to amend multiple contracts simultaneously. Additionally, it should be noted that the earlier a contract is transitioned away from LIBOR to a risk-free reference rate, the more likely further changes will be required to reflect changes in market practice around the use of these new rates.
- Despite some LIBOR interim deadlines shifting (please refer to our previous alert, available here), market participants should avoid entering into agreements or arrangements that refer to LIBOR or, in product classes in which the use of an alternative reference rate is not yet practically feasible, ensure that such contracts may be easily amended;
- Market participants should consider the impact of potential unavailability or inadequacy of hedging in relation to exposures referring to LIBOR (including potential accounting issues) and the challenges of coordinating transition away from LIBOR in transactions where related contracts across product classes exist, as the markets for different products may be at different stages of transition and/or may favour different rate-setting approaches; and
- Companies should implement a LIBOR transition plan as a tool for prudent and sound management, as this may be viewed in the market as a proxy for good governance and compliance.