In Ghana today, interest rates for many credit agreements; be it short term (0-12months), medium to long term (1-5years) or long term (above 5years) refer to the U.S. Dollar London Interbank Overnight Rate (“LIBOR”) as the benchmark rate in Ghana.
LIBOR is an interest rate calculation that is used globally for purposes of debt capital market transactions including the issuance of bonds, loans and derivatives.
In particular, LIBOR underpins many Floating Rate Notes (“FRNs”), which use the rate as a reference for purposes of calculating coupon.
The intention is that LIBOR reflects the overall health of the financial system, which in turn is reflected in the coupon rate to be paid or received with regards to FRNs on the International Capital Market (ICM).
LIBOR is calculated by taking a cross-section of the average interest rate at which one bank can borrow from another bank. Interestingly, in the last several years however, LIBOR has been subject to a scandal of rigging, fraud and collusion amongst these banks.
As a result, the UK Financial Conduct Authority (“FCA”) has urged banks and institutions to move to other benchmarks by 2021, and will no longer require or encourage banks to publish these rates following 2021.
Globally, LIBOR transactions are worth over $300 trillion of global loans and its phase-out presents issues for all debt instruments that use LIBOR as a reference rate. This means that any issuer of FRNs or other debt instruments must be aware of this development and should take a closer look at their debt.
Subsequent action may be required in light of the imminent discontinuation of LIBOR. Issuers thinking about issuing debt in the future must also be aware that the FCA has urged firms to start thinking about using alternative benchmarks and treat the LIBOR discontinuation event “as something that will happen and which they must be prepared for.”
In Ghana, the situation is no different. Since 2007, Ghana has issued 7 Eurobonds on the ICM. The maiden 10-year bond which was issued in October 2007 was paid off October 2017.
The Government through the Ministry of Finance (MOF) continues to maintain its presence on the market raising various amounts to implement the government`s debt strategy partly for budget support and Liability management operations.
As at December 2018, the total maturity value of Eurobond instruments stood at $5.7m, but through a liability management programme, the government bought back about $771.9m leaving an outstanding balance of $4.9m. As per the table below, the issuances have maturity dates that go beyond 2021 deadline i.e. 2022 to 2049.
The question is what happens to these contractual transactions after the phase-out? Market participants must plan and act appropriately. For example, if a market participant manages a portfolio of floating-rate notes based on LIBOR, what happens to the interest rates of these instruments if LIBOR stops being published? What does the documentation provide; does fallback language exist and, if it exists, does it work correctly in such a situation? If not, will consents be needed to amend the documentation? Consents can be difficult and costly to obtain, with cost and difficulty generally correlated with uncertainty.
Summary of Ghana`s Outstanding Eurobond Issuances end 2018
What led to the LIBOR Phase-out?
In July 2017, the FCA announced the discontinuation of LIBOR after certain banks in the UK provided purported interest rate figures which did not truly reflect the rate at which they could borrow. This led to the distrust in LIBOR as an indicator for the real health of the global economy.
The FCA announced that LIBOR will be discontinued in 2021, and different jurisdictions are currently considering alternatives to LIBOR. Possible alternatives include the Secured Overnight Financing Rate (“SOFR”) for the US, the Sterling Overnight Index Average (“SONIA”) for the UK, the Swiss Average Overnight Rate (“SARON”) for Switzerland and the Tokyo Overnight Average Rate (“TONA”) for Japan.
Though SOFR,” has been proposed; nevertheless, there remain significant uncertainties surrounding the transition. For public companies that have floating rate obligations tied to LIBOR, there a significant risk.
What this means for debt capital market participants
Market participants are urged to review all their existing agreements that use LIBOR and that do not mature by 2021, in order to determine whether these contracts have fallback clauses built-in for the situation where LIBOR ceases to permanently exist. If these contracts do not have adequate fallback clauses, market participants ought to amend these contracts accordingly.
Most loans based on the standard Loan Market Association (“LMA”) form contain a provision that covers the situation in which LIBOR temporarily ceases to be available. In such a case, the lender’s cost of funding or a stipulated Reference Bank Rate is used.
However, as this fallback aims to provide temporary relief, rather than cover a situation in which LIBOR permanently ceases to be available, this fallback can present further issues. After 2021, the FCA will not require Reference Banks to continue publishing rates and in any case, administering this fallback will be costly in the long term.
Further, the LMA has been aiming to ease the transition of the discontinuation of LIBOR by publishing an optional “Replacement of Screen Rate” clause, which was revised in mid-2018. This clause allows flexibility for the parties to choose a replacement benchmark following LIBOR with a majority-lender consent.
Again, the Asia Pacific Loan Market Association (“APLMA”) has followed suit, and its agreements contain a modified version of the LMA’s “Replacement of Screen Rate” clause. APLMA’s standard clause stipulates that a majority of lenders must approve a change of benchmark but typically requires unanimous lender consent if the benchmark would result in a reduction in the amount of interest payable.
Recommendation ahead of the LIBOR phase-out?
Evaluate existing fallback provisions in legacy transactions
It is very crucial for banks and the government to review legacy LIBOR contracts that extend beyond 2021 to determine if the current fallback language is adequate to provide a smooth transition to another reference rate. Primary consideration will be the calculation of interest in adjustable-rate instruments in the absence of LIBOR. Amend contract language for those agreements as needed, in compliance with banking, securities, and consumer protection laws. Also, the legal counsel must determine if changes to contracts require the consent of various parties named in the agreements.
Language for LIBOR transactions going forward must be developed
While addressing the fallback language in legacy contracts earlier signed, there is the need to develop the fallback language for new transactions going forward, providing for a smooth transition to a new reference rate. Also, prepare this language for compliance with banking, securities, and consumer protection laws
Convene a team to supervise the transition
The Bank of Ghana in conjunction with the Ghana Association of Bankers must establish a structured team led by a senior executive and comprising representatives from treasury, loan operations, accounting, legal, information technology, risk management, communications, and others as needed to develop a transition plan, oversee its execution, and report regularly to the board of directors. They must also come out with an impact assessment plan as well as a possible effect on the Ghanaian economy
Take stock of existing LIBOR transactions
As already indicated, offshores borrowings as well as some interbank lending (Loans and Derivatives SWAPS) are perked to the LIBOR rate. There is, therefore, the need to quantify all financial exposure to the LIBOR and estimate the impact that a LIBOR phase-out may have on hedge effectiveness, interest-rate risk, basis risk, and valuations. Per the 2018 annual public deport report presented to the parliament by the MOF, the total value of securities maturing in 2049 stood at USD4.97bn, this accounted for 50.6% of the total external commercial debt portfolio. There are other corporate issuances and other SWAPS transactions by the banks.
Impact on accounting, tax, and systems implications
There is also the need to critically assess changes to systems, models, and other operational processes that will be triggered by the LIBOR phase-out. Accounting systems, loan systems, pricing models, risk models, and other management information systems will likely require changes. To some lenders, this may come with additional cost and their accounting reporting standards.
Mitigate the risk of disputes and create mechanisms for handling disputes
Whenever the need arise for parties to amend contract terms or draft terms for new transactions, lawyers involved must ensure that the risks of disputes with borrowers or other parties to such contracts are mitigated. Further to this, such terms must include procedures and mechanisms to handle any disputes that may arise.
Adopt a communications strategy
Indeed due to the interested parties involved in these transactions and the ripple effects it may have on underlying clients, it is necessary to develop a communication strategy to inform cherished customers and all relevant parties.
Adopting best practices and staying abreast of industry developments
As usual, staying above the curve is very important. The processes to stay up to date on developments in the industry on the LIBOR phase-out and transition to SOFR must be made known, and take advantage of industry best practices around contract language and operational processes as they become available.
The exact timeline for implementing the alternative reference rate will, of course, depend on market and industry developments. The most critical action today is to begin planning with the understanding that plans will need to be revisited regularly and adapted as developments occur.
The other most import thing is to up the planning committee to undertake a rigorous impact assessment on this development ahead of the transition.
Credit: Ministry of Finance, Bank of Ghana, Dorsey.com, FHLBank Atlanta. Miriam Amoako
Disclaimer: The views expressed are personal views and doesn’t represent the institutions the writer works for.
About the writer
Carl Odame-Gyenti is a third-year PhD (Financial Management) candidate, a Finance and Telecom enthusiast, managing local and global Investors, Intermediaries, Non-Bank Financial and Financial Institution relationships with an international bank in Ghana. He has embarked on several international assignments in London, Singapore, Dubai, Kenya, Nigeria and Southern African markets. He has a passion for youth and community development.
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