In the UK, the Tough Legacy Taskforce set up by the Working Group on Sterling Risk-Free References Rates (RFRWG), this week drew attention to the considerable difficulties and challenges that the demise of LIBOR (by the end of 2021) is causing with some legacy contracts. These contracts, coined ‘tough legacy’ contracts, often do not contain robust fall-back provisions and were highlighted in the taskforce’s Paper on the identification of Tough Legacy issues issued on 29 May 2020.
On the one hand, the taskforce indicates that a legislative solution of some kind would be preferable for such tough legacy contracts, but on the other, it acknowledges that such a ‘blunt instrument’ is unlikely to deliver the economic balance, which the regulators are demanding, and, in many cases, may not be what the parties to transactions want or had intended.
The taskforce identified the following asset classes/markets in which tough legacy contracts may, to varying degrees, exist:
The taskforce concluded that, because (i) adoption of the various options available to the parties of uncleared derivatives (allowing them to convert their LIBOR exposures into Risk Free Rate (RFR) exposures) is entirely voluntary and (ii) a derivative may be used to hedge an exposure which is itself a tough legacy contract, ‘there is a case for action to address tough legacy exposures in the derivatives markets’.
It has been noted for some time that the bond market has numerous tough legacy contracts (hence a dedicated LIBOR transition subgroup looking at the bond market, the RFRWG’s Bond Market Subgroup) but the taskforce did highlight that some of these tough legacy bond contracts are, in fact, being transitioned to RFRs through consent solicitation.
Despite the positive step towards cessation of LIBOR in these contracts, this manner of transition was, nevertheless, considered unfeasible for the entirety of the bond market. The taskforce, therefore, concluded that action should be taken in order to address the tough legacy contracts in this market.
Whilst in both types of loan markets, parties to the facility agreements are free to renegotiate the fall-back provisions (or lack of them) and indeed are encouraged to do so, the taskforce considered that this mass renegotiation process will be inadequate. It, instead, concluded that further action would be needed to facilitate the transition to RFRs in order to meet the deadline of the end of 2021.
Due to the unstandardised nature of LIBOR fixed mortgage contracts, many of these either contain weak variation clauses or no fall-back provisions at all. Although there may not be many of such LIBOR referenced mortgage contracts, the taskforce noted that the damaging impact of the lack of sufficient fall-back provisions contained within them, would be such that further action to facilitate their transition to RFRs is needed.
The taskforce noted that the need for action in respect of each asset class has increased due to the Covid-19 pandemic, because the efforts to prepare for LIBOR’s cessation have been put on pause by many participants in the markets in which the asset classes predominantly feature.
In order to combat the legacy contract difficulties found in each asset class, the taskforce recommended:
Despite giving these recommendations, the taskforce did appreciate the practical difficulties in their implementation; not only because of the doctrine of the sanctity of contract but more importantly because of the dangers of implementing a ‘one size fits all’ approach to contracts with different characteristics across a broad spectrum of asset classes.
With such a large number of asset classes containing difficult legacy contracts to be addressed and so many other current demands on resources, it is difficult to see how UK regulators and government can respond to the taskforce’s latest paper and its recommendations. However, there appears to be little political or regulatory appetite to postpone the end of 2021 date and clients should continue to assume LIBOR will no longer be quoted in its current form beyond that point and that ‘tough legacy’ contracts need to be identified and addressed.
This article has been co-written with Iris Bajraktari, a trainee solicitor in the corporate team.