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Horizon 2020

Debt forecast

Libor transition, creditor risk and flexible covenants


Partner, New York


Counsel, New York

Libor switch presents opportunities

In 2021 the London Interbank Offered Rate (Libor) is set to be discontinued. The benchmark establishes an average rate at which banks are willing to borrow from one another, and is used to calculate interest and other payments in roughly $300tn of financial contracts around the world.

Financial regulators decided to phase out Libor primarily because there are almost no borrowings between banks in Libor any more, and because the institutions that helped set it were found to have been rigging a proposed rate in their favor. In its place will come alternative benchmarks in each of the five Libor currencies (dollars, euro, sterling, Swiss franc and yen), although progress towards transition remains patchy across the various markets and the effort is not coordinated on a global basis.

The Libor replacement process will affect any business that borrows debt with a floating interest rate, or which has derivative instruments underpinned by Libor or its equivalents. These companies will need to negotiate replacement reference rates with their lenders and hedge providers and may need to amend their debt contracts. However, those that act now will ensure an orderly transfer ahead of time, save money and ultimately reduce their risk of disputes with lenders in transitioning to a new rate.

Sustainability offers route to lower costs

Greater focus on sustainable practices and disclosure is allowing companies to reach new pools of equity capital while cutting debt costs.

SLLs offer issuers lower margins when they meet certain ESG criteria; further evidence that sustainability has become a driver of genuine bottom-line growth.

The green financing market is growing year-on-year, with almost $36bn of ‘sustainability linked loans’ (SLLs) issued in 2018 alone. The number of money market funds that incorporate environmental, social and governance (ESG) metrics is also expanding rapidly, with assets rising 15 percent to $52bn in the first half of 2019, according to analysis from Fitch Ratings. While only a fraction of the total money market sector, their growth reflects rising demand from investors for sustainable products.

SLLs offer issuers lower margins when they meet certain sustainability criteria, providing further evidence that sustainability has moved beyond corporate social responsibility to become a driver of real bottom-line growth.

How to mitigate creditor risk

Boards of companies with debt traded on the syndicated markets need to be mindful of their creditor base in the year ahead.

There is a rising risk of creditors who hold short positions in loans and bonds in the credit default swaps market pressuring borrowers to declare defaults. Boards can protect against this threat by ensuring that their company has robust consent rights over trades, and by negotiating provisions in debt agreements that limit voting rights and/or the right of such creditors to declare defaults after a certain time period has passed. These provisions prevent or deter such creditors from buying into a syndicate in the first place.

However any defensive measures must be used with care, given that they have the potential to raise the price of future debt.

Revisit debt agreements to enhance competitiveness

Finally, companies should take a fresh look at any credit documentation based on forms that are more than a year or two old, particularly if they have near-term strategic priorities that require investment or want to enhance their ability to respond to the unexpected.

In general, borrowers in the debt markets have been able to agree ever-looser covenants in the years since the financial crisis, and at present it is possible to negotiate flexibility with lenders to avoid seeking waivers and consents in the future. Revisiting past agreements can therefore help position companies to be more competitive when responding to market opportunities and challenges.

There is a rising risk of creditors who hold short positions in loans and bonds in the credit default swaps market pressuring borrowers to declare defaults.