Libor transition: How issuers should manage the consent solicitation process

3 August 2022
The London interbank offered rate, or Libor, has been a benchmark for establishing borrowing terms around the world since 1986, used in tens of millions of contracts covering everything from mortgages and student loans to global bonds and derivatives. But Libor’s shortcomings, which mainly include a vulnerability to manipulation revealed by several crises and scandals, led global financial regulators to replace it with more secure benchmarks.

The deadline for switching US dollar Libor to another benchmark is 30 June 2023. That may seem a comfortably far-off deadline, but the consent solicitation process required for contracts without fallback provisions is long and complex. The best time to have started was a year or two ago. Given that many loans are still tied to Libor, the second-best time is right now.

The history of Libor

Libor was established by polling several large international banks on their current borrowing costs, removing outliers and averaging the responses.

Libor was so useful that eventually more than US$300 trillion in floating-rate loans and derivatives contracts traded in global financial markets were indexed to it, from large investors to small businesses that needed to borrow funds to support day-to-day operations. Libor was quoted in five major currencies: UK pounds sterling, Swiss francs, euros, Japanese yen and US dollars.

Starting with the 2008 financial crisis, however, concerns grew about relying on this index to determine global rates. Then, several rate-rigging scandals revealed just how easily Libor could be manipulated.

Even though Libor's flaws had been clear for some time, it was so deeply embedded in banking industry operations that banks resisted any change for more than a decade. Deals and agreements continued to rely on Libor while neglecting to add adequate fallback language about rates if Libor ceased to be valid. So-called “tough legacy” contracts also posed the problem of being unable to convert to a non-Libor rate or be amended with fallbacks.

Now that Libor is finally being phased out, legacy bonds with inadequate fallback clauses must be transitioned to new benchmarks. These new benchmarks are called alternative reference rates (ARRs), and examples include the Secured Overnight Financing Rate (SOFR) in the United States, the reformed Sterling Overnight Index Average (SONIA) rate in the United Kingdom and the Tokyo Overnight Average Rate (TONA) in Japan.

Both the United Kingdom and Japan began their transitions early, and their bonds are now more than 90 percent transitioned to updated indexes. The United States is behind. The key to transitioning bonds without fallback provisions to SOFR is a well-managed consent solicitation process with all stakeholders.

Understanding the challenges of consent solicitation

Transitioning from Libor requires establishing a replacement rate, identifying and locating investors, communicating with them to solicit their approval for changes, and implementing those changes. This may sound simple, but the process can be complex and time-consuming, and success is never guaranteed. It is sometimes difficult to determine who the investors are and locate people whose contact information is outdated. In addition, some companies may no longer exist, and in some cases, documentation could be legally required in multiple languages. It’s also important to note that legacy transactions can involve many parties, including advisors, agents, trustees and sponsors, as well as  investors. This process can take from a few months up to two years.

First steps

The first step for the issuer is to identify the rate. This is complex yet quickly achievable, driven by the existing documentation and financial analysis, followed by scenario testing to confirm the best rate.

After this, the investors of the contracts must be contacted to approve the rate and the amendment to the documentation, with the call to action being to vote on the solicitation. Approval typically requires majority consent by value. This can involve tens of millions of contracts, ranging from large institutions to small retail investors anywhere in the world.

You can contact investors in a variety of ways. A fundamental approach is using clearing houses, such as Clearstream and Euroclear. Servicing agents and trustees may also have contact information. Public notice can also be issued.

With a 50-percent-plus consent requirement, it’s essential to contact as many investors as possible through as many means as possible. All parties to the deal have a fiduciary/contractual responsibility to support the consent process. In places where the the desired information is unavailable/not forthcoming, the issuer needs to rely on trusted existing relationships to maximize the reach of their consent solicitation.

Communications must be clear about the terms and the reason for the modification if investors are to have confidence in the proposal.

Companies must also set up a straightforward process for responding to investor queries, which may be more abundant than you expect. Prompt, clear and helpful responses can significantly increase investor approval rates.

Even in the most optimistic scenario, only a fraction of contacted investors will attend the meeting and vote, so it’s necessary to contact the highest proportion of investors possible with the consent solicitation. Failure to meet the threshold of approval by the majority of value invested will lead to added costs and delays.

The consequences of not getting approval

If the original contract doesn’t have the proper fallback language and investors have not consented to the new contract, the documentation can’t legally be changed. This can lead to a mismatch of cash flows that may affect investor returns and make future sales of the investment more difficult. Amending documentation and getting consent is significantly more cost-effective for both note holders and investors.

The Libor Act, passed into law in the US in March 2022, reduces some of the potential adverse economic outcomes by enabling the replacement of existing language with specified fallback language, so that such contracts will fall back to the recommended risk-free rate based on SOFR.

Nevertheless, while this law minimizes some risks, it should be regarded as a safety net when all other efforts have failed. The lack of scenario testing will increase the risk. Any contract will work better with tested and approved benchmark language.

Bottom-line advice

If you haven’t started your process, start it now. Do the research, analysis and scenario testing to establish your rate. When you contact investors, use every avenue you can in parallel, including a clearing house, trustee and servicing agent, as well as direct contact as an issuer. Use every available bit of contact data, and then look for more.

When you do reach stakeholders, hold valid meetings and provide them clear information supported by evidence so they have confidence in your chosen rate and will vote to approve.

Consent solicitation in five steps
  1. Identify all stakeholders and actively notify them.
  2. Field inquiries.
  3. Coordinate counsel and other agents to work with all transaction parties.
  4. Structure a process to manage all consent solicitations concurrently to prevent the transaction ratings from being downgraded, while delivering cost savings to investors.
  5. Communicate regularly to foster trust.