235,900: This figure represents the number of contracts in the UK that have yet to transition from reliance on London Interbank Offered Rates (LIBOR) to the new Sterling Overnight Index Average, or SONIA, according to January 2022 data from the Financial Conduct Authority (FCA). These contracts include interest-rate derivatives, bonds, securitisations, loans, mortgages and other products. They represent £472 billion in value, per the FCA.
By all accounts, the various stakeholders in the UK financial services sector – ranging from regulatory authorities and issuers to trustees, bondholders, noteholders, and others – have performed remarkably well to transition the vast majority of contracts to SONIA prior to the phase out of most LIBOR settings on 31 December 2021. Yet, clearly, more work needs to be done to complete this process that is vital to the most efficient operation of the capital markets.
To characterise the scope of work that needs to be performed and some of the key priorities that stakeholders should consider, Wilmington Trust recently convened a discussion of internal and external constituents who have been closely involved in the sterling LIBOR transition for many months. The panelists included:
- Rob Leach, Group Director, Treasury & Tax, for Marston’s, the UK’s leading independent brewing and pub retailing business
- Andrew Petersen, a Partner with Alston & Bird with more than 20 years of experience in international structured finance
- Alex Pashley, a Director and Head of Structured Finance for Wilmington Trust in the UK
- Daniel Wynne, a Director and Trustee, Restructuring and Default Specialist for Wilmington Trust in the UK
- Stuart Watson, Head of Corporate Services for Wilmington Trust in the UK
Where we are now, how we arrived here
To review, in June 2021, this identical group of thought leaders met and discussed their perspectives on the LIBOR transition. The panelists discussed the impact of the changes as seen in the market together with the various strategies firms are implementing to work towards the prior deadline of 31 December 2021 implementation.
The panel gathered again in Q1 2022 and began by reviewing important milestones over the second half of 2021, highlighted by the cessation of publication of 24 out of the 35 LIBOR settings on New Year’s Eve. This included all seven sterling versions, all seven Japanese yen versions, all seven Swiss franc versions and one-week and two-month U.S. dollar versions of LIBOR rates.
In the months and years leading up to this milestone date, international corporate trust, and corporate services providers such as Wilmington Trust and law firms like Alston & Bird worked closely with issuers such as Marston’s to ensure that all counterparties were prepared to transition away from LIBOR to other equivalent indices. These efforts focused on what our panelists referred to as KYR – or Know Your Risks. This analysis proved vital in identifying an issuer’s full exposure to novation, examining which contracts required redress, ensuring all reference rates within a transaction moved to complimentary alternative reference rates and undertaking comprehensive communications work with all bondholders/noteholders and as needed, bilateral negotiations with them and other transaction parties.
As if these strategic projects were not challenging enough under a strict deadline, every stakeholders’ efforts were impacted by Covid-19 and the far-reaching consequential impact the global pandemic caused. Some factors were relatively minor, such as being unable to meet with bondholders/noteholders in person to form a quorum, discuss novation and secure agreement. Other factors were existential, as in the case of issuers like Marston’s. The company is a leading pub operator employing roughly 12,000 people across an estate of around 1,500 pubs, bars and lodges across England, Wales, and Scotland. It also has a 40% holding in Carlsberg Marston’s Brewing Company which brews popular brands such as Carlsberg and Pedigree, and has the UK distribution rights for San Miguel, Estrella Damm, and others. Beginning in 2020, a combination of Covid-19 related restrictions and three national lock down periods in just over 12 months have had a severe impact on Marston’s operations and revenue.
“With each of those lock down periods came the requirement to obtain waivers or covenant amendments from our lenders and our noteholders. Wilmington Trust was a vital partner in this work.” explained Marston’s Leach. “So, we’ve gotten to know our noteholders very well over the past two years. We have worked together with our noteholders, Wilmington Trust, and other advisors to obtain the necessary covenant waivers and safely navigate through the potential debt problems caused by periods of pub closure and restricted trading."
Simultaneously, Leach and his team have been collaborating closely with Wilmington Trust to successfully manage the transition of the company’s securitised debt from a LIBOR reference rate to a new SONIA rate. “We’ve obtained financing through a 30-year securitisation, with the first notes issued in 2005,” said Leach. “As with all types of long-term financing, there is a very stringent rulebook that has to be followed in order to protect the interests of the noteholders. Wilmington Trust, as the director of the note-issuing company since first issuance in 2005 assisted with the reference rate amendments which helped keep us on track to meet noteholder expectations.”
By teaming with experienced service providers, Marston’s was able to fully complete the move from LIBOR to SONIA well before 31 December 2021 — in fact, Marston’s was one of the first companies in its sector to complete the transition of a securitization transaction to SONIA – which allowed more resources to focus on its efforts to successfully maintain the business despite the extraordinary challenges posed by Covid-19.
The new (temporary) reality of synthetic LIBOR
Of course, not all organisations were able to transition as effectively and efficiently as Marston’s. The nearly 236,000 outstanding contracts in the UK is clear evidence of that reality. For them, financial regulators have introduced the concept of synthetic LIBOR as a stopgap reference rate. “Synthetic LIBOR was designed for a relatively small group of so-called ‘tough legacy’ contracts that requires more time for novation.” said Wilmington Trust’s Pashley. Looking back on 2021 when it became clear that synthetic LIBOR would be available in 2022, Wilmington Trust’s Wynne described it as a “parachute” to facilitate a soft landing for issuers and their service providers.
However, our panelists were unanimous in expressing the theme that no issuer now reliant on synthetic LIBOR should feel a sense of comfort or complacency. In fact, Marston’s Leach noted a sense of “nervousness” among some issuers with contracts currently pegged to synthetic LIBOR. That apprehension is justified for those organisations that have not yet worked with their service providers to develop a clear roadmap for moving from synthetic LIBOR to SONIA or who have encountered issues with implementing plans that were formulated.
The FCA (and other regulatory authorities) have made it clear that synthetic LIBOR is a temporary fix. The FCA has only committed to publishing synthetic versions for one-month, three-month and six-month sterling LIBOR rates and yen LIBOR settings for 2022. In a recent post on its website, the FCA explained that synthetic LIBOR is designed to “mitigate the risk of widespread disruption to the significant number of legacy LIBOR contracts which have not converted by or at end-2021.” At the same time, the FCA pointed out that synthetic LIBOR will not be a permanent solution. “We have already made clear that synthetic yen LIBOR will be for one year only, ceasing at end-2022.” the authority wrote on its website.
As this paper was being written in early February 2022, the FCA had not yet announced whether or not it will extend synthetic sterling LIBOR beyond the end of this year. The regulator had offered that in 2021 when it was considering synthetic LIBOR for 2022, the “case” for publishing three-month sterling LIBOR was stronger than for one-month and six-month reference rates. Based on this assessment, it’s reasonable to conclude that no issuer should assume that, at the very least, one-month and six-month synthetic LIBOR will continue to be published over the long term. Overall, the FCA was unequivocal in its stance on the future of synthetic LIBOR when writing in late 2021: “All the synthetic rates will cease in due course, and none will be continued simply for the convenience of those who could take action to convert, [sic] but have not bothered to do so.”
It’s also important to note that all new contracts that would have originally relied upon any of the LIBOR reference rates that ceased publication on 31 December 2021 must rely on SONIA. Relatedly, Alston & Bird’s Petersen noted, “In November 2021, the FCA also confirmed that the use of U.S. dollar LIBOR will be prohibited for UK regulated firms in most new contracts written after December 2021. So those firms must convert any legacy U.S. dollar LIBOR contracts by the middle of 2023.”
The path forward from synthetic LIBOR
The guidance from the FCA could not be more apparent. Issuers that now rely on synthetic LIBOR should be in the process of planning to transition contracts to SONIA. Based on their extensive real-world experience in navigating this path, our panelists discussed the key roadblocks and considerations for issuers in order for them to make substantial progress in 2022.
From Wilmington Trust’s perspective as an institutional trustee and corporate services provider, an important component of this work will entail contacting and communicating with bondholders/noteholders regarding these contracts. Throughout 2021, issues arose with engaging with bondholders/noteholders in order to reach the necessary quorum to agree novation. Some of these challenges involved pre-existing conditions, such as outdated custodian contact lists that made it more difficult to successfully reach market participants. Other factors were more transitory, such as issuers and their trustees having to compete for mindshare with bondholders/noteholders who were receiving multiple solicitation offers simultaneously in the run up to the 31 December 2021 LIBOR sunset date.
To solve for this in 2022, experienced trustees and international corporate services providers such as Wilmington Trust are working closely with other skilled service providers to strategically engage with clients’ bondholders/noteholders. “Synthetic LIBOR announcements moved a hard deadline into a much more flexible system, albeit one that cannot be consistently relied upon because it is subject to renewal every year,” said Wilmington Trust’s Watson. “What we’ve been doing is working very hard with information agents to contact bondholders and noteholders. We’re happy to say many of our clients’ outstanding deals are basically there now with regard to quorum.”
The added cushion of time afforded by synthetic LIBOR enables issuers to reschedule meetings that were adjourned without a quorum in 2021, as well as to invest the necessary hours and resources to contact bondholders/noteholders who have been difficult to reach to secure their agreements on novation.
For issuers, this type of work is absolutely critical to minimise ongoing costs. Harkening back to the panelists’ contention that issuers emphasise KYR – Know Your Risks – in regard to LIBOR transition, Wilmington Trust’s Wynne pointed out that they should be fully aware of the expenses involved in engaging with all missing bondholders/noteholders to reach a quorum and gain agreement. “It’s imperative for the market to leverage assistance from experienced corporate service providers and trustees to ensure that that work is completed as quickly and efficiently as possible,” he said. “Now is not the time to become complacent. It’s about completing the process with speed and accuracy to curtail long-term costs for the transactions.” The reality is that most or all of these costs will ultimately be passed on to bondholders/noteholders, so it is important that issuers move now to mitigate the risk that any stakeholder can claim an issuer took on excessive costs in its efforts to transition from synthetic LIBOR to SONIA.
By all accounts, the work to successfully transition the vast majority of contracts from reliance on LIBOR to SONIA prior to the 31 December 2021 deadline marks a significant achievement for the UK financial services sector. The fact that this work was accomplished in the midst of a global pandemic underscores the determination and agility of the stakeholders that got us to this point. “We have been there to support our clients through these challenging times and this unprecedented transition,” said Wilmington Trust’s Pashley. “We pride ourselves on being a relationship-oriented firm. So, we have faced these challenges right alongside our clients and worked through them in partnership. We are proud to say that, together, we have achieved so many successful outcomes. But we also know the work is not finished yet.”
The need to transition the small-but-significant number of outstanding contracts from their reliance on synthetic LIBOR to SONIA or another suitable alternative reference rate as quickly and efficiently as possible is imperative. What’s needed is the continued focus of issuers, trustees, and corporate services providers with a keen eye on details and a redoubled commitment to engaging with those bondholders/noteholders who did not vote in the process in 2021 or prior. It’s a legal and ethical obligation we have to every market participant, and one that issuers and service providers will no doubt fulfill.
For more information
To learn more about Wilmington Trust’s Structured Finance Services available in the UK, please contact Alex Pashley at (44)207-397-3611, Daniel Wynne at (44)207-397- 3627, or Stuart Watson at (44)207-397-3657.
Wilmington Trust’s domestic and international affiliates provide trust and agency services associated with restructurings and supporting companies through distressed situations.
This article is for educational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.