Changing the fund financing facilities to replace LIBOR as the primary benchmark interest rate has all the makings of a potential disaster for the customer experience of your fund-sponsoring clients. This is not just theoretical – we are starting to see real relationship tension developing in practice as a result of the modification process. Below you will find our suggestions for best managing the customer experience towards a favorable outcome for your fund sponsors.
Communication. No one on the negotiating team is enthusiastic about changing the documents to replace LIBOR. Banks have (rightly) the impression that they are bothering their Fund borrowers with this burden of amendment. Therefore, they may seek to minimize it and often communicate the need for changes through junior portfolio management staff to junior Fund treasury staff. It is a mistake. These changes are major commitments that could impact the fundamental economics of the transaction and should be communicated at the relationship level. Early communication about a game plan and process by a team that knows the process and the complexities is important in setting the stage for a successful transition.
Inquire. CFOs of fund sponsors feel that these changes are quite straightforward, involving a single sentence that takes the term âLIBORâ and replaces it with âSOFRâ throughout the Credit Agreement. But it is far from a “find and replace”. Many CFOs don’t understand, and can’t expect them to understand, all the nuances (especially in multicurrency installations with syndication players) to make the required changes. There is no way for a banker to effectively explain the scope and extent of changes required for a particular transaction if they are not fully conversant with what needs to happen, why it is needed, and when it needs to be completed. . You need to understand the differences in approach for different currencies, between bilateral and syndicated loans, and between the US and UK markets. SOFR comes in several primary varieties, with many other options (including basic economic concepts, such as applying a spread adjustment or a floor), which will need to be agreed upon. You can’t leave the details to the lawyers or your juniors if you want to make sure your client is well informed of the process.
Manage expectations. At the outset, the Senior Transaction Banker should explain to the Fund’s CFO or other high level Fund contact:
(i) It’s difficult, none of us asked for it, but it’s demanded by global regulators and we don’t really have a choice.
(ii) It is much more documentation than your expectations. The changes cross the entire Credit Agreement: definitions, loan request mechanisms, interest rate selections for each currency, applicable margin calculations, downtime and illegality sections , etc. The Credit Agreement will almost always need to be amended and reworded – it is not a one-page amendment.
(iii) The CFO himself must be attentive and engaged – the gaps change. The CFO must understand and approve the new spread parameters and their intersection with the new benchmarks, which requires in-depth and high-level attention.
(iv) There are huge variations in the scope of work required between different transactions. A bilateral US dollar deal only on a non-LSTA credit agreement can change quite simply, perhaps 10 to 15 pages of blacklining. But for a multi-currency deal, where each currency now has its own interest rate instead of LIBOR, along with its own definitions and mechanisms, the amendment may require 50 to 60 pages to change black lines. For transactions with many currencies, each must be handled individually. And unionized agreements are even more complicated. Each bank may have different requirements regarding notice periods for certain currencies, which rates are preferred and operationally supported (for exampleSOFR forward, compound SOFR in arrears, simple daily SOFR), etc. Make sure your Funds contact understands that not all transactions will be changed in the same way and has a good idea of ââthe complexity of the change for a particular transaction.
(v) Time and expense matter – we are seeing CFOs expecting the costs of these changes to be only a few thousand dollars. The entire credit agreement should be re-read, amended and reworded by experienced lawyers – the expense will be considerable on the part of the bank’s law firms and borrowers, and not go out and send a message up front and honestly won’t end well. This is not a situation where the CFO thinks invoices are 10% higher than expected; Invoices for syndicated multicurrency transactions can reach 10 times their expectations if not properly guided.
Hourly. Your fund’s CFO and his treasury team, along with their law firm, are busy making investments and raising money (things that are really close to their hearts). Because there is no cash funding involved here and no deadline around a LIBOR amendment from the Fund’s point of view (there are, in fact, deadlines quickly approaching for banks), LIBOR amendments are naturally treated as low priority and lag behind. When the comments come back four weeks later, the banker and senior lawyer naturally need some time to cool off, which drives up costs. Encourage your fund’s CFO to set and follow a timeline, communicate it to fund counsel, and encourage everyone to stick to it. And get started! LIBOR will disappear on 12/31/21 for currencies other than the US dollar, and these changes coincide with a very busy trading environment. And even simple amendments here can take time. Waiting to tie the LIBOR change to a potential upcoming trade change regarding the terms of the trade can prove to frustrate the timing of the change to the terms of the trade, further annoying the client.
Practical solutions. There are some transactions where the borrower’s need for multi-currency borrowing is a good thing to have, not a need to have. Make sure your fund CFO knows that removing the ability to borrow in currency is a pragmatic approach, albeit with a loss of flexibility, which may avoid the need for major surgery on the terms of the loan. currency in the credit agreement. We see this approach used where possible, particularly in older transactions where the Funds are later in the lifecycle.
The syndicate. The lead bank should contact the union members before starting the preparation for the amendment, especially in multi-currency transactions. Not all banks are equipped to handle each new interest rate benchmark. Identifying these type of challenges early in the process and not during the feedback phase can be very helpful.
Borrower’s Comments. Help your fund’s CFO understand the comment environment. Banks are undertaking a massive project implementing these changes across their portfolio of all LIBOR-based asset classes – in many cases literally thousands of separate loans. Standardized arrangements for each bank usually come from a centralized LIBOR working group (not the Fund Finance team or its law firm), and there are often significant differences in approach between banks. Every agreement and often every word in the new benchmarks has been thoroughly reviewed by the internal teams of each bank (legal, risk, operations, IT, swaps teams, pricing) over several months in order to develop standard provisions. that operate in the required environment. Thus, each bank naturally has an institutional preference for compliance and consistency with its policies. As always, we fully respect the right of Fund borrowers to comment, and they should comment in any languages ââthey deem appropriate. But comments on LIBOR succession have to go through many more levels of approval than typical transactional terms: changes have to go through, for example, the centralized LIBOR team at the bank as well as, sometimes, even the LIBOR teams. computer systems (to ensure that any changes are actually possible from the point of view of new computer systems and software). And, in a syndicated deal, this is true for every bank in the syndicate. Banks’ receptiveness to commentary in this area is not surprisingly less accommodating than on trade matters under the decision-making rights of Fund Finance’s trading teams – banks are much more resistant to change in this area to ensure stability. a coherent standard that they, as an institution, can both implement and live up to. So, managing comments here is a lot more time and money consuming than usual. Borrowers should be expressly made aware of this so that they understand the correlation in this context with costs and time when deciding whether a particular comment is essential, pleasant or not necessary. A fund CFO who is unaware of this reality will end up frustrated.
Legal teams. Banks should encourage their law firms and fund CFOs to encourage their own law firms to form dedicated teams comprising senior members of the applicable negotiating team and any necessary LIBOR transition specialists. Many business lawyers are very familiar with LIBOR transition issues, but often not for all applicable currencies, nuances or operational differences. LIBOR lawyers, in turn, are not necessarily familiar with the intricacies of the bank and the transaction in question. Cross-expertise may be required in certain circumstances. Also, the substantive changes here are in places very complex and cannot be competently handled by new freshmen, for example. Let’s agree with the teams.
Accomplishment. When the change is complete, the bank’s relationship manager should call and thank the customer. Although it was no one’s fault, the Fund will have allocated real time and costs to the project. Let them know it’s appreciated and ask for feedback – we should all try to learn and make the process more efficient each time we go along. Also give feedback to your law firms.
Conclusion. I really see this as an area that can have significant negative impacts on your customer relationships if it is poorly managed. We should all do our best to try to avoid this. If anyone has any other suggestions on how to improve the efficiency of the process, I would appreciate it.