October 26, 2021
Kenya | Action required for LIBOR transition
On 5 March 2021, the United Kingdom Financial Conduct Authority (FCA) and ICE Benchmark Administration (an authorized administrator, regulated and supervised by the FCA) announced the decision to cease publication of the long-standing London Inter-bank Offered Rate (LIBOR) on the basis of panel bank submissions.1 This paved the way for a full transition away from the use of LIBOR, affecting financial contracts in various jurisdictions
At the end of 2021, financial services in Kenya will begin to apply alternative interest rates in financial contracts and agreements as opposed to LIBOR. This means that any financial contracts which refer to or rely on LIBOR will be rendered ineffective after 31 December 2021.
Globally, regionally, and locally, LIBOR is referenced in most loans, equity-linked notes, mortgage, commercial and derivative contracts and incorporated into most financial activity such as risk, valuation, and performance modelling. The change, therefore, may require action to change risk profiles, as well as requiring changes to commercial terms, risk models, valuation tools, product design and hedging strategies.
In anticipation of this transition, financial firms - banks, asset managers, insurers, and investment companies in Kenya - have set up transition teams to manage the process as financial firms are likely to be most affected by these changes. Such transition teams are expected to review “legacy” contracts to confirm that they contain provisions for continuity for instance through reliance on alternative interest rates in the absence of LIBOR or contain sufficient mechanisms of calculation of interest.
Some of these contracts contain existing fall-back provisions (temporary or otherwise) which could be relied upon in the interim as further amendments are undertaken. Elements such as spread adjustments in the contracts would also need to be analyzed. The contracts may eventually need to be significantly revised or amended to include new reference rates, which may lead to renegotiations of loans given the impact of new rates.
While this is ongoing, it is incumbent upon counterparties, including corporate clients, to activate their own internal mechanisms to ensure they are aware of any changes to existing securities or facility documentation and the overall effect of these changes.
Of equal importance is for internal legal teams to review existing commercial contracts with third parties that may have references to LIBOR, just as financial institutions are doing. A well planned and executed approach in the review of contracts will enable legal teams to anticipate and address the legal risks and exposures that will accompany this transition.
From the onset, it is necessary to identify and compile all contracts that reference LIBOR. A good place to start would be contracts with financial institutions such as bank facility or credit arrangements and insurance contracts. Thereafter, teams should identify other commercial contracts that specifically reference LIBOR in payment terms or default trigger provisions and other clauses.
Where these contracts are digitized, the process becomes much easier as the digital repositories are quicker to navigate where there are many contracts to review. This may also provide teams with an understanding of which contracts are primarily in physical form and that need to be scanned and uploaded onto digital channels.
Prioritization and review
The next step would be to review provisions of these contracts to ensure adequate alignment with the new structures. Care should be taken not to engage in a “find and replace” exercise. Teams should understand the new applicable reference rates and their effects, whether it be SONIA (Sterling Overnight Index Average) for the United Kingdom or SOFR (Secured Overnight Financing Rate) for the United States, which are applicable for dollar denominated loans. Legal Counsel may be called upon to explain the necessary changes being made to key contracts and the legal impact, therefore external legal support should be sought where necessary.
Additionally, where there are many contracts to review and renegotiate, the legal team should identify the important contracts in terms of exposure and risk and prioritize them.
The review should result in: (i) reasonable comfort that contracts contain adequate provisions to protect a business during the transition; or (ii) drafting of key amendments to address the transition from LIBOR which may by necessity incorporate new reference interest rates.
Where amendments are made, they should be shared with counterparties for approval. This should also be managed appropriately to ensure that third parties do not interpret the same as a renegotiation of the entire contract.
While this process may not be completed before the end of the year, it can help legal teams identify and prepare for areas of risk and legal exposure for instance where LIBOR gets volatile before its overhaul or is unrepresentative upon transition. This may even help justify a case for increased commercial resources to be committed to the review and negotiation process to protect the firm’s interests.
For additional information with respect to this Alert, please contact the following:
Ernst & Young (Kenya), Nairobi