London Interbank Offered Rate (“LIBOR”) is the most important and most common international market benchmark interest rate for global lenders, bond issuers and the other market participants in a variety of financial products and transactions such as loans, bonds, derivatives, etc. It is set each day by collecting quotes from a panel of banks on interest rates they would charge for different loan maturities, and these are averaged together to provide a range of LIBOR rates.
However, in 2012, LIBOR was involved in a series of highly publicised scandals and extensive investigations into the way LIBOR was set uncovered a widespread, long-lasting scheme among several major financial institutions colluded with each other to manipulate LIBOR rates for profit. In the midst of the manipulation scandal, it was discovered that there were very few transactions taking place to support some of the currencies and tenors for which LIBOR was published. As such, LIBOR submissions were largely based upon expert judgement rather than transaction data. This led to concern that LIBOR was unrepresentative and vulnerable to potential manipulation.
Although the administrator of LIBOR, the Intercontinental Exchange Benchmark Administration, has taken a number of steps to reform LIBOR, the rate fixing scandal and the absence of active underlying markets raises a serious question about the credibility and sustainability of the LIBOR benchmarks. Finally, in July 2017, the British Financial Conduct Authority (“FCA”) announced that it would no longer compel or persuade banks to make submissions to LIBOR as from the end of 2021. On 5 March 2021, FCA further announced that as from the end of 2021 LIBOR for all currencies and tenors will either cease to be published or cease to be representative of the market.
The phase-out of LIBOR will have significant impacts on unexpired products and financial documents based on it. For instance, loan contracts with interest rates that refer to LIBOR would need to be amended to reflect the replacing rate, and naturally, the question also comes whether the existing security and guarantee would be able to continue to secure the obligations under those amended contracts.
In this context, we have summarized the issues that have been asked of us by a number of international banks as well as Chinese banks and prepared a few questions with answers, touching some of the key legal issues involved:
Q1: Where finance documents are amended to transition away from LIBOR referenced interest rates, would security or guarantees governed by the laws of PRC, given in support of the debt obligations under those finance documents, extend to secure and/or guarantee the debt obligations as amended without further action?
A1: It depends. There is no straightforward answer. Under PRC law, if any amendment to the finance documents increases the secured liabilities, the written consent of the security provider or the guarantor must be obtained so that the security or the guarantee can extend to cover the secured liabilities so increased. Otherwise, it will only be liable for the original scope. So, it comes to a question of fact that whether the transition is going to increase the liability or not? We may reply it from a theoretic perspective: if it does increase the liabilities, then written consent will be necessary; otherwise, not. As it happens, the replacing rate could be floating and it is impossible to tell the effect at the outset, so it is always advisable to get the written consent so as to avoid any uncertainty. In general, replacing the interest rate without the consent of the security provider or the guarantor could be problematic especially if the security provider or the guarantor raises objection at the time of the enforcement, so it is always better to get the written consent for each amendment in respect of the interest rate.
Q2: In relation to the above question, does it matter whether or not the finance document(s) include(s) construction language expressing that they refer to those finance document(s) as from time to time amended and/or restated or the security or guarantee is expressed to secure debt obligations incurred in relation to finance document(s) as from time to time amended and/or restated?
A2: There is no straightforward answer to this question. PRC law is silent on whether the security provider or the guarantor is able to give prior blanket consent for the purpose stated in our answer to Question 1. Judicial practice on this issue is not consistent either. Different PRC court frequently holds different views on the effectiveness of such pre-approval, so again it is always advisable to get the written consent from the security provider / guarantor in respect of the replacement of the interest rate.
Q3: What steps can parties take to ensure the validity of the security or guarantee which will extend to the obligations under the finance documents after they are amended?
A3: For each single amendment to the finance documents, unless it is absolutely certain that this is not going to increase the secured liabilities, it is advisable to always get the written consent of the security provider or the guarantor so as to make sure that the security or the guarantee will cover the liabilities as amended.
Q4: Are there any other considerations to be made to ensure the continuing validity of security or guarantees under the laws of PRC where the underlying finance documents are amended?
A4: If a financing transaction constitutes a foreign debt (that is a cross-border borrowing by an onshore entity from an offshore entity), there would be additional consideration in the aspect of foreign exchange control. A foreign debt is required to be registered with the competent branch of the State Administration of Foreign Exchange (“SAFE”) within a prescribed period after the date of the foreign debt contract and any change to the key contractual terms, such as the amount, the interest or the tenor, should be registered as well. Otherwise, the parties would not be able to proceed with the drawdown, repayment and/or payment of interest (as the case may be). The replacement of the applicable interest rate is a major change to the contractual terms and follow-up change registration with SAFE should be done within a prescribed period after such change.
Likewise, SAFE procedure will also be relevant if the security or guarantee constitutes a NeiBaoWaiDai, where an onshore security provider / guarantor provides security / guarantee to an offshore debt, that is both the creditor and the debtor are offshore entities. This is a kind of cross-border security / guarantee required to be registered with SAFE within 15 business days after the security / guarantee contract pursuant to PRC Law. Absence of SAFE registration may prevent the security provider / guarantor from remitting money offshore for performing the security / guarantee obligations and thus affect the enforcement of the security / guarantee. The replacement of the interest rate would also be a key change to the cross-border security / guarantee and needs to be registered with SAFE within 15 business days after such change.
Edward Song has also contributed to the article.