On 12 November 2020, the Asia Pacific Loan Market Association (“APLMA”) published two discussion draft facility agreements (the “Facility Agreements”) referencing risk-free reference rates (“RFRs”) for US dollar syndicated loan transactions in the Asia Pacific region. Until recently, there has been a lack of market standard for RFR calculation formulae, pricing methodology, and institution operational practice in the Asia loan market.

Each Facility Agreement draft employs a different methodology for calculating the Secured Overnight Financing Rate, or SOFR, which is the RFR for US dollars: compounded daily SOFR and daily simple SOFR.

The Facility Agreements demonstrate key drafting concepts and elements, as well as calculation methodologies, required in transitioning Asia syndicated loan documentation from referencing IBOR to referencing a relevant RFR. The APLMA does not recommend, nor support, any particular pricing or calculation methodology, and notes that due to the absence of market practice, the Facility Agreements do not represent a standard position on these issues.

The APLMA welcomes comments and feedback on the Facility Agreements prior to 4 December 2020.  Based on such feedback, the APLMA aims to provide recommended template forms as soon as possible. This will greatly assist institutions in meeting the various IBOR transition milestone objectives set by the regulators.

Transition Milestones

The Hong Kong Monetary Authority, in consultation with the Treasury Markets Association, has set the following transition milestones for banks in Hong Kong:[1]

From 1 January 2021:

Banks should be in a position to offer products referencing the appropriate RFR to LIBOR

Adequate fallback provisions should be included in all newly issued LIBOR-linked contracts that will mature after 2021 (in light of the effective date of ISDA’s IBOR Fallbacks Protocol, this transition milestone for derivative contracts can be achieved by the end of January 2021)

By 30 June 2021:

Banks should cease to issue new LIBOR-linked products that will mature after 2021

Key points related to the Facility Agreements
  1. The Facility Agreements are based on the English law facility agreement standard form published by the APLMA on 18 May 2020.
  2. The Facility Agreements follow: (a) the calculation methodologies and other conventions issued by the Working Group on Sterling Risk-Free Reference Rates in September 2020 (rather than the ARRC recommendations for syndicated loans published in June 2020, although the two approaches are similar); and (b) the Exposure Draft of the Rate Switch Agreement (without observation shift) published by the Loan Market Association on 11 September 2020 (rather than Loan Syndications and Trading Association documentation, which is more common in the United States).
Issues for consideration

In the accompanying guidance note to the Facility Agreements, the APLMA has highlighted the following material issues for the market participants to consider with respect to the transition from LIBOR to RFR:

  1. Calculation of breakage costs and whether such costs are appropriate in the absence of match funding;
  2. Applicability of a zero interest rate floor;
  3. Fallback waterfall for non-availability of a daily RFR and the use of cost of funds as an ultimate fallback;
  4. Frequency of interest rate notification to borrowers given the daily change in overnight rates;
  5. Use of the pro rata method to distribute interest among incoming and outgoing lenders;
  6. Suitability and relevance of market disruption provisions in the absence of match funding; and
  7. Consent threshold for further changes to the reference rate (e.g. for the use of term SOFR, when available).
Asia to speed up in LIBOR transition

While the above issues are not unique to the Asian syndicated loan market, Asia has been slow to develop market practice for these issues, compared with the rest of the world. With the recent publication of the Facility Agreements, the Asia syndicated loan market is expected to quickly catch up on the LIBOR transition highway. Advice to market participants who plan to close deals with their Asian counterparts – buckle up!

[1] Reform of Interest Rate Benchmarks, Hong Kong Monetary Authority, 13 November 2020