level , the ISDA Benchmark Supplement , which has been developed by hedge dealers to provide uniform fallbacks across all hedge transactions in a portfolio .
ISDA is currently in the process of updating the 2006 ISDA Definitions to incorporate new fallbacks relating to permanent discontinuation of certain “ IBORs ”, the IBOR Fallbacks .
The ISDA Benchmark Supplement is drafted so that once the 2006 ISDA Definitions are updated and the IBOR Fallbacks are implemented , those new fallbacks will apply in priority to the fallbacks set out in the existing ISDA Benchmark Supplement . It is expected that ISDA will soon publish the IBOR Fallback Protocol and supplement , which will facilitate the inclusion of the new fallbacks in existing non-cleared IBOR derivatives transactions between counterparties .
The LMA ’ s recommended definition for a Screen Rate Replacement Event , which is the triggering event for the replacement of the benchmark screen rate , lists certain events leading to a replacement of the interest rate that are objective , such as : “ the supervisor of the administrator of that Screen Rate publicly announces that such Screen Rate has been or will be permanently or indefinitely discontinued ”.
However , this definition also includes certain events that are not objective , such as :
“ in the opinion of the [ Majority Lenders ] and the Borrower , that Screen Rate is otherwise no longer appropriate for the purposes of calculating interest under this Agreement ”).
Although the lender and the hedge provider in a project financing are often the same financial institution , they will wear different hats as they negotiate the terms of the financing and so a Screen Rate Replacement Event that can be unilaterally triggered by agreement between the lenders and the borrower can be problematic for hedge providers and vice versa .
Unless the terms of the hedging agreement track the trigger event in the related loan agreement , the ISDA trigger event may be similar , but not identical to , the LMA Screen Rate Replacement Event definition .
Such ISDA regimes will most likely follow the ISDA Benchmark Supplement , which updates the 2006 ISDA Definitions to include fallbacks that would apply following the Permanent Cessation Events – which are public statements or publication of information by the relevant supervisor or administrator that Libor has ceased to be provided – or the Pre-cessation Events – which are , again , public statements or publication of information by the relevant supervisor or administrator that Libor is or will no longer be capable of being relied on or is non-representative of the underlying market or economic reality that it is intended to measure .
The objective measures in the LMA definition of Screen Rate Replacement Event do , more or less , align with the ISDA Permanent Cessation
Events definitions . That said , Pre-cessation Events are still not a wholly objective test .
A trigger event under a loan agreement and its associated interest rate swap that gives rise to a unilateral determination made by different parties , ie the lenders or the hedge provider , is potentially problematic for a project financing .
Basis risk and other issues When a trigger event occurs under the loan or hedging agreement , the finance documentation will typically require the relevant parties to inform the facility agent , who , in keeping with its general coordination role , will inform the other group accordingly .
It is possible , and indeed likely , that this will give rise to a period of time in which the parties will discuss and consider the proposed replacement benchmark . If all parties can agree to the replacement benchmark , then there is an easy transition to the new rate in accordance with the various provisions in the finance documents that allow for the documents to be amended with minimal , if any , additional approvals .
However , not unreasonably , the various parties will need to consider at the outset of the financing what should be the outcome in a scenario where the proposed replacement benchmark is not accepted by the lenders or hedge providers . This means that , prior to the Libor transition , participants in new project financings have had to consider how best to document and allocate the following risks :
1 – A mismatch in the timing for the trigger event under the loan agreement and the associated interest rate swap , meaning that the floating interest rate risk under the loan is no longer offset by the swap , basis risk .
Both ISDA and ARRC are working towards aligning the Permanent Cessation Events and Pre-cessation Events , which may , in time , create consensus in the market for SOFR related RFRs for US dollar loans . This would mean that any timing mismatch for US dollar loans and hedging agreements would not affect the rate replacement decision-making process , irrespective of whether the triggering event occurs under the loan or the hedge .
2 – The market standard for benchmark rates for the loan market and the swap market could differ .
There are already different manifestations of the SOFR RFR , such as a Term SOFR , a daily SOFR and a SOFR compounded in arrears or advance . If the replacement benchmark under a loan agreement is different from the proposed replacement benchmark under a hedging
Both ISDA and ARRC are working towards aligning the Permanent Cessation Events and Pre-cessation Events
62 Project Finance International September 23 2020