DISCONTINUATION OF LIBOR: POSSIBLE IMPACTS ON NIGERIAN CORPORATE AND SOVEREIGN FINANCING

A. INTRODUCTION

For short, medium and long-term business or development plans, corporates and sovereigns (federal, states and local governments) access funds through varied means of finance. When corporates access funds by way of debt financing or through the derivatives market, this is usually in the form of loan facilities, debentures, bonds, exotic financial instruments etc. In the case of sovereigns, access to funds are usually through revenue allocations from federation account, savings; or debt financing, which is usually in the form of loan facilities, sovereign bonds etc.

When any of the above debt financing transaction is internationalised i.e. obtained from a foreign lender (commercial, investment, development or multilateral financial institutions) or traded in an international capital market or even by way of syndicated lending, the interests payable on the borrowed amount are in most cases benchmarked on the LIBOR, which is formerly an acronym for London Interbank Offered Rate.[1] In an entirely domesticated transaction, interest may be benchmarked on NIBOR i.e. the Nigerian Inter-Bank Offered Rate, which represents the short-term lending rate of selected banks in the Nigerian inter-bank market; or in some of these transactions, the LIBOR may still be used as the benchmark interest rate.

This paper examines LIBOR and its expected discontinuation in 2021 and the possible impact and material risks it could pose for Nigerian market participants (corporates and sovereigns) and their legal, tax, financial and accounting advisors that work on these transactions that references the LIBOR.

B. LIBOR AS AN INTEREST RATE BENCHMARK

LIBOR is the rate at which a bank could obtain funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size before 11.00 London time. It is an interest-rate average calculated from estimates submitted by leading banks in London. As at today, it is the primary benchmark, along with the EURIBOR for short-term interest rates around the world.

Presently, LIBOR is quoted in five currencies - US dollar, British pound sterling, euro, Japanese yen and Swiss franc. After the 2013 reforms, LIBOR rates are now calculated for seven (7) maturities or tenors - 1 day, 1 week, 1 month, 2 months, 3 months, 6 months and 12 months based on submissions from a reference panel between 11 and 16 banks for each currency resulting in the publication of 35 rates every applicable London business day.[2]

The Alternative Reference Rates Committee ("ARRC") of the United Stated Federal Reserve Board and the New York Federal Reserve ("NYFed") in its 2018 Second Report stated that there is an estimated US$200 trillion in notional transactions referencing the US dollar LIBOR in the cash and derivatives markets with more than US$35trillion worth of these transactions extending past 2021.[3] Given that LIBOR is quoted in five major currencies of the world, one could then imagine the enormous influence it has on financial, capital and derivatives markets across the world. It is important that a consideration of some of the transactions that it is used in is carried out.

1. Loan Facility Agreement

A typical interest clause in a Loan Facility Agreement[4] entered into by a Nigerian corporate or sovereign with a lender (commercial, investments, development or multilateral financial institutions) may provide as follows:

"Interest

Calculation of Interest

The rate of interest on each Loan for each Interest Period is the percentage rate per annum which is the   aggregate of the applicable [US LIBOR] [Base/Reference] rate as that rate may be adjusted from time to time.

Payment of Interest

The borrower shall pay accrued interest on each Loan on the last day of each Interest Period (and, if the Interest Period is longer than six Months, on the dates falling at six monthly intervals after the first day of the Interest Period).

Default Interest

....

Notification of rates of interest

(a) The Agent shall promptly notify the relevant Lenders and the Borrower of the determination of a rate of interest under this Agreement [(including any adjustment to the [US LIBOR] [Base/Reference] Rate during any Interest Period)]

(b) [(The Agent shall promptly notify the Borrower of each Funding Rate relating to a Loan.]"

2. Loans from International Finance and Development Institution

International Finance and Development Institutions such as the World Bank, International Monetary Fund and the African Development Bank that lend to member countries benchmark the interest payable on their loans with the LIBOR or similar reference rates like the EURIBOR, JIBAR etc. For instance, with effect from July 1, 2018, IBRD Loans are subject to different maturity premium based on income and other factors. For instance, the rates released by the World Bank for lending in US Dollars to Nigeria[5] are as follows:

Fixed Spreads as of July 1, 2019

Average Maturity Bucket                     US Dollar 

up to 8 years                                          LIBOR + 0.65 % 

8+ to 10 yrs                                            LIBOR + 0.85 % 

10+ to 12 yrs                                           LIBOR + 1.00 % 

12+ to 15 yrs                                           LIBOR + 1.20 % 

15+ to 18 yrs                                          LIBOR + 1.45 %

18+ to 20 yrs                                         LIBOR + 1.60 % 


Variable Spreads as of July 1, 2019

Average Maturity Bucket                   US Dollar

up to 8 years                                         LIBOR + 0.49 % 

8+ to 10 yrs                                           LIBOR + 0.59 %

10+ to 12 yrs                                         LIBOR + 0.69 % 

12+ to 15 yrs                                         LIBOR + 0.79 % 

15+ to 18 yrs                                         LIBOR + 0.89 % 

18+ to 20 yrs                                        LIBOR + 0.99 %

3. Derivative Transactions

Nigerian market participants usually enter into derivatives transactions that references the LIBOR as the interest rate benchmark. These are contracts between two or more parties whose value are based on an agreed-upon underlying financial assets, currencies, interest rates, indexes or securities. Future contracts, forward contracts, options, swaps are the common type of derivative contracts.

It is important to point out that the Securities and Exchange Commission of Nigeria regulates the derivatives market pursuant to Section 28 of the Investment and Securities Act ("the Act") 2007, which requires every securities exchange to be registered with and regulated by the SEC. Section 315 of the Act defines a securities exchange to mean an exchange or approved trading facility including amongst others options, futures exchanges, over the counter market and other derivatives exchanges. Further, Section 54 of the Act stipulates that where a public company enters into a derivatives transaction, such a transaction must be registered with the SEC. In addition to the SEC, Exchanges like the Nigerian Stock Exchange ("NSE") and the FMDQ OTC also provide a trading platform as well as guidelines for the trading of derivative contracts in Nigeria.

Across the world, the standard documentation used for derivatives transactions is that developed by the International Swap Dealers Association ("ISDA"). In practice, parties adopt the ISDA document as a template and modify according to fit the peculiarities of their transactions. It follows that references to interest payable on any of the underlying assets can be benchmarked with the LIBOR.

C. TRANSITION FROM LIBOR TO OTHER REFERENCE RATES

In 2021, private-sector banks reporting information used in the determination of LIBOR will stop doing so. The effect of this is that LIBOR will no longer serve as an interest rate benchmark. The immediate impact of this transition or retirement of LIBOR is that contracts or transactions that are LIBOR benchmarked, that extend beyond 2021 will be left with no interest rate if they do not have an alternative reference rate. This will also trigger a possible dispute between the parties on the likely interpretation of these contracts especially in relation to finding an acceptable rate that will meet the expectation of the parties, a reference rate that will not alter the dynamic of the contract by converting a floating rate obligation to a fixed rate obligation.

The preceding paragraph highlights issues that pose several finance and legal risks. Thus, there is a need for parties and their financial or legal advisers to device risks mitigating considerations. Some of the considerations[6] are -

  1. Does the market participant have exposure to contracts with terms beyond 2021 that is benchmarked with LIBOR? If yes, are these contracts material?
  2. Dealing with the interpretation of these contracts in terms of the effect of LIBOR transition, workability of the contract in the absence of LIBOR and possibility of amendments, if necessary.
  3. Identifying an alternative refence or benchmark rate and evaluating possible impact of this new rate on the contract, especially in terms of profitability, additional costs or hedging of risk.

Financial and legal advisors should also consider whether new contracts should still reference LIBOR given its wide-ranging acceptability in the financial markets across the globe. However, if LIBOR is to be retained in these new contracts, then there should be the inclusion of alternative reference rates to fill the void to be created by the discontinuation of LIBOR in 2021. If LIBOR will not be used in the new contracts to be entered into by the market participant, then what other reference rate(s) should be used that will not adversely affect the workability of the contract.

In terms of other business risks as well as short, medium and long-term investment, there is a need to consider the effect of the transition of LIBOR on investment strategy, products, accounting and processes already adopted and being implemented for the entity's investment. This should involve a holistic evaluation of risks from the client's financial, operational, regulatory, technological-capacity perspectives.

D. CONCLUSION

Presently, there are several initiatives at the international level aimed at developing credible and generally accepted alternative interest rates to LIBOR. The ARRC has published fallback language for new issuances or contracts. These fallback languages seek to provide interest rate provisions that will function upon the expected discontinuation of US$ LIBOR and promote general consistency in defining key terms such as benchmark transition events, benchmark replacement and benchmark replacement adjustments. In 2019, ISDA plans to update the definition of US$ LIBOR to include a fallback to Secured Overnight Financing Rate ("SOFR") in the event of a permanent discontinuation of USD LIBOR.[7]

The above discussion does not call for panic, it requires prudence on the part of market participants to carry out a due diligence exercise especially in relation to their investments or financial obligations that are LIBOR benchmarked and to begin the process of mitigating those risks that might be associated or connected with the 2021 discontinuation of LIBOR. This can be achieved by consultation with their legal, tax, financial and accounting advisors.

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*Author - Mr. Ikemefuna Stephen Nwoye

                   Principal Chief Counsel - NWOYE (Barrister and Solicitor)

Disclaimer: This paper should not in any way be used as a substitute for legal advice or opinion. The views expressed are personal to the author and do not necessarily reflect the views of any organisation or person that the author is or might have been affiliated to. 

[1] Eurobonds which are usually over one year are benchmarked with the US Treasury Rate.

[2] "ICE Benchmark Administration (IBA) ICE LIBOR" IntercontinentalExchange. available at https://www.theice.com/iba/libor accessed on 23 July 2019.

[3] US Securities and Exchange Commission Statement on LIBOR Transition available at https://www.sec.gov/news/public-statement/libor-transition accessed on 24 July 2019.

[4] Sample clause from Loan Market Association (LMA) Secured and Unsecured Term Facilities Agreement Template.

[5] World Bank IBRD Financial Product available at https://treasury.worldbank.org/en/about/unit/treasury/ibrd-financial-products/lending-rates-and-fees. accessed on 24 July 2019. See also the AfDB applicable lending rates for Sovereign and Non=sovereign guaranteed loans available at https://www.afdb.org/en/documents/financial-information/lending-rates accessed on 25 July 2019.

[6] See also supra note 3.

[7] SOFR is a broad-based US Treasury repo financing index based on actual transactions rather than submissions. Available statistics show that SOFR will aggregate nearly $800 billon in daily repo transaction volumes. Daily publication of the SOFR began on April 3, 2018.