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It is nearly one year since AMJ hosted a presentation (in conjunction with Hanif Virji of Vivadum Limited, financial services experts) on 8 March 2020 to leading regional and Omani financial institutions, government authorities and other large corporates, in attendance at the Sheraton Hotel, Muscat.  In our presentation, among other things, we discussed the impending cessation of LIBOR (and its transition to risk free rates) and its implications for lenders and borrowers.

At the time of our presentation, LIBOR was due to cease to be published by the end of 2021 for all currencies which use it. For now, this still remains to be the case, however, the administrator of LIBOR, ICE Benchmark Administration (“IBA”), has declared that following a consultation it intends to delay the cessation of the publication of LIBOR until June 2023 in respect of the overnight, and 1, 3, 6 and 12 month settings of US dollar LIBOR. The US and UK regulators also issued statements supporting the intentions of the IBA consultation which closed for comment on 25 January 2021. We expect that the IBA will share its feedback following its consultation at some point in February or March 2021 and that it will re-affirm its intentions at that time.

The expected cessation of the publication of the US dollar LIBOR settings mentioned above should provide some respite to banks and borrowers with US dollar loans in Oman, most of whom have been grappling with adapting to the “new normal” due to the implications of the Covid-19 pandemic over the last year or so, to give them more time to put in place mechanisms to transition transactions from US dollar LIBOR to risk free rates.

US and UK regulators continue to advise and encourage banks to cease entering into new agreements which use US dollar LIBOR as a reference rate in favour of risk free rates as soon as possible and in any event by the end of 2021.  However, until there is a generally accepted alternative this will be difficult for banks to adhere to.  

“Fallback” wording (such as that suggested by Alternative Reference Rate Committee (ARRC) or the Loan Market Association (LMA)) may be considered by lenders and borrowers to contemplate the proposed transition from LIBOR to risk free rates, however, it remains to be seen how, and in what way, this language may be adopted in Omani law documentation.

We expect that a number of finance agreements that have been entered into on the basis of US dollar LIBOR (and not amended to contemplate cessation of publication of LIBOR) may be amended closer to the time of its cessation (or perhaps refinanced if no agreement can be made as to relevant fallback).

If you have any legal / documentation concerns about LIBOR cessation please do get in touch with Marcus Pery (Partner) (marcus.pery@amjoman.com) or Robert Calleja (Associate) (robert.calleja@amjoman.com).

We can also put you in touch with Hanif Virji of Vivadum Limited (hv@vivadum.com) if you would like to know more of the financial implications of LIBOR cessation for your business (both lenders and borrowers).

We include a short summary on LIBOR and the proposed changes to it, below.

What is LIBOR?

LIBOR is an acronym which stands for “London Inter-Bank Offered Rate” which is (in simple terms) an average of interest rates calculated from estimates submitted by a leading group of banks in London in the five leading world currencies (US dollar, Euro, British pound sterling, Japanese yen, and Swiss franc). LIBOR has been in formal use since 1986. Both international and local banks operating or lending to businesses in Oman use LIBOR (representing its borrowing cost element) as a basis plus a margin (representing its profit element) to charge interest to their borrowers on US dollar loans. The change to the way that the LIBOR element is calculated is likely to have an impact on pricing of US dollar (LIBOR based) loans and the repayment / close out mechanics in respect of them.

Why is LIBOR being stopped?

The well-publicised manipulation of LIBOR which led to criminal investigations and sanctions imposed by regulators on prominent banks and bankers led to a call for alternatives to LIBOR. Additionally, the number of transactions with appropriate size and term to qualify for submitting by banks for LIBOR setting purposes has been in decline which reduces the reliability of LIBOR to be used as a benchmark. As a result, a number of alternatives to LIBOR are being assessed in favour of what are known as “risk free rates” which are difficult to manipulate and are a true reflection of interest rates without a credit spread.

Risk free rates (“RFR”)

Risk free rates, or RFRs, are actual overnight interest rates – it concerns the borrowing and lending of cash for 24 hours. The major difference between RFRs and LIBOR is that LIBOR is forward looking and therefore encompasses an element of risk pricing which does not feature in RFRs which are backward-looking (hence the name “risk free” rates). This has the result that using RFRs interest rates cannot be determined upfront and calculations of amounts due for any given interest period will have to be done at the end of the interest period. Under LIBOR, interest rates are known upfront and therefore the calculation of interest due at the end of an interest period can be done at the start of that interest period, which provides more certainty, which is partly the reason why LIBOR has proved to be so popular. Its popularity, and its ease of use, is probably one of the reasons why the IBA has taken the decision to enter into a consultation to delay US dollar LIBOR’s cessation.  

What is the significance of the cessation of the publication of LIBOR?

A number of studies have analysed the financial implications of the cessation of the publication of LIBOR. Generally, LIBOR is a higher rate than RFR because RFR does not include a credit spread. Therefore, if lenders wish to attain LIBOR equivalent rates using RFR, the RFR would need to include an extra (credit) spread in its calculation. This almost certainly would cause a financial impact depending on the value of the credit spread and how it is calculated.

Getting used to the way that RFRs are calculated will take some time for bankers and businesses to become familiar with. There are likely to be operational costs associated with this.

As mentioned above, the RFRs provide less certainty over interest payments payable at the end of interest periods and when prepaying loans. Using RFRs borrowers may wish to monitor daily interest rates more closely (as these will be compounded over the course of the interest period) to help determine how much cash is required to cover interest due at the end of that interest period.

Under LIBOR, break costs, which are charged when amounts are repaid during an interest period (i.e. “breaking” the interest period), can include a windfall for lenders (depending on how it is calculated). Using RFRs, break costs should not be applicable as there is no forward looking interest rate period to “break” and therefore lenders may wish to include additional charges applicable to loan prepayments.

Lenders and borrowers may wish to amend finance documentation to contemplate the cessation of LIBOR in finance documentation using “Fallback” wording (as mentioned above).

Hedging contracts (e.g. interest rate swaps) are commonly entered into in respect of term loans. If the loans that are subject to the hedging are changing their benchmark rate, the appropriate changes should be made to hedging contracts.

Other alternatives

For US dollar loans, there may be a viable alternative in using the American interbank offered rate, called Ameribor. We understand that Citibank has entered into an alliance with the American Financial Exchange (Ameribor’s administrator). This is a forward looking rate, in the same way that LIBOR is and is therefore likely to enjoy the same advantages (such as price certainty at the beginning of interest periods), but also be vulnerable to the disadvantages (such as manipulation), of forward looking rates.

For more information in relation to:

• the legal implications of alternative rates, RFRs and LIBOR cessation, please get in touch with Marcus Pery (pery@amjoman.com) or Robert Calleja (robert.calleja@amjoman.com)
• the financial implications of alternative rates, RFRs and LIBOR cessation, we can put you in touch with Hanif Virji of Vivadum Limited (hv@vivadum.com)