UK: Market Disruption Clauses In Syndicated Loan Agreements

Background

Market disruption clauses, commonly found in syndicated loan agreements, set out how the interest rate applicable to a loan will be calculated in the event that either:

1) LIBOR/EURIBOR cannot be determined (on the basis that no screen rate is available and none or only one of the reference banks nominated in the loan agreement can provide a rate); or

2) one or more of the lenders in the syndicate notify the Facility Agent that the cost of their funding in the London interbank market in respect of that loan exceeds the LIBOR/EURIBOR rate applying to that loan under the terms of the loan agreement.

The effect of these clauses is that lenders can increase the interest rate charged to a borrower to reflect the actual costs of funds to those lenders.

Recent market events and the liquidity crisis have put market disruption on the agenda for many market participants for the first time. Lenders in respect of various Asian loans have been one of the first to invoke market disruption provisions, for example a US$1.035 billion dual-tranche loan for Taiwanese electronic parts and components manufacturer Hon Hai Precision Industry and Quanta Computer's US$360 million loan. This trend is expected to be followed in Europe and the US, raising a number of issues as to how the standard clauses work in practice.

Who Can Invoke a Market Disruption Clause?

Usually, only a lender (or lenders) whose participation in a loan aggregates 30 percent or 50 percent (the specific percentage is a matter of negotiation) is entitled to trigger a market disruption.

However, well-advised borrowers will have amended the Loan Market Association ("LMA") standard wording to make clear that the market disruption clause can be invoked only where a bank is unable to fund all or part of a requested loan as a result of "circumstances affecting the Relevant Interbank Market generally". This expressly avoids the borrower paying for a lender's own lack of creditworthiness.

The Applicable Rate of Interest in the Event of Market Disruption

If a market disruption provision is invoked, LIBOR/EURIBOR will cease to form part of the calculation of interest, and the rate of interest will be calculated on a lender-by-lender basis using the rate notified by each lender to the Facility Agent as being that lender's cost of funding its participation in the loan (from whatever source it reasonably selects), together with the applicable margin and mandatory costs.

This revised calculation applies to all lenders in the syndicate and not just to those who invoked the market disruption. The Facility Agent is then required to calculate the interest rate payable to each lender in the syndicate by reference to the rate notified by each lender as its individual cost of funding. Unless otherwise agreed between the parties, the Facility Agent cannot apply a blended rate.

What Is a Reasonable Source of Funding?

In calculating its cost of funding, a lender can utilise funds from any source "it may reasonably select". In the event that a borrower disputes a lender's source of funds, loan agreements do not typically include a mechanism for resolving such a dispute, nor do they impose an obligation on the lender to demonstrate the reasonableness of its funding decision.

Furthermore, lenders are not under a contractual obligation to justify their funding decisions if asked to do so by a borrower.

Does the Borrower Have Any Involvement in Selecting an Alternative Basis of Funding?

If a market disruption clause is invoked, either the Facility Agent or the borrower can require the other to enter into negotiations for a period of not more than 30 days with a view to agreeing upon a substitute basis for calculating the interest rate.

In reality, however, this negotiation right will not assist a borrower, as the Facility Agent is unlikely to agree to an alternative basis of funding which is not approved by the lenders; to be effective, any alternative basis of funding requires the approval of each lender in the syndicate.

Issues for the Borrower

If a lender does choose to invoke the market disruption clause, this will raise a number of issues for the borrower, including (but not limited to):

1) the ability of the borrower's cash flow to service the increased interest payments;

2) the strength of the borrower's financial covenant performance and whether it will be adversely affected by the change in interest rate under the loan agreement; and

3) the cost to and the ability of the borrower to amend any existing interest rate hedging arrangements to ensure that the amount it receives under such hedging is sufficient to pay the increased interest costs under the loan agreement, given that there are typically no market disruption provisions relating to LIBOR/EURIBOR in interest rate hedging documents.

How Likely Are Lenders to Invoke a Market Disruption Clause?

To date, the market disruption clause is largely untested, and from a relationship perspective, banks have previously been reluctant to use it. In addition, there are conflicting opinions as to whether lenders should invoke market disruption clauses in the current market.

The LMA standard syndicated facility agreement provides for LIBOR and EURIBOR to be fixed by references to the applicable Reuters screen rate. The screen rate is derived from quoted rates supplied by a panel of 16 reference banks selected by the British Bankers Association which may not correlate to the syndicate in question. Being an average rate, LIBOR/EURIBOR may not be an accurate reflection of a lender's actual cost of funds.

Furthermore, there is a concern that in the current market conditions, the quotes provided by panel banks for the purposes of calculating the displayed screen rates for LIBOR and EURIBOR are not always a true reflection of those banks' costs. This is because the banks are concerned that if they quote their actual costs of funding, it may trigger discussion in the market about their own creditworthiness. Clearly it is an issue for borrowers if banks are not providing accurate information and market disruption clauses are, as a consequence, invoked. It is unpalatable for borrowers if banks can abandon the transparent system of displayed screen rates and instead charge borrowers interest rates based on the individual costs of funds of each bank. For the agent of loans, this is a cumbersome way to calculate interest on syndicated loans.

The Association of Corporate Treasurers ("ACT") believes that this current market phenomenon of LIBOR being unrepresentative of banks' cost of funds should not be a basis for lenders to invoke market disruption clauses. The ACT would expect a market disruption clause to be invoked as a last resort and only if banks are generally experiencing exceptional difficulty in raising funds in the interbank market or are paying materially more for interbank deposits than the displayed screen rates for LIBOR or EURIBOR.

However, despite the proposal of the British Banking Association, the future application of market disruption clauses is currently unclear.

Is There an Alternative to Market Disruption?

A possible alternative to market disruption which is currently being discussed is for interest rates to be calculated based on market-based pricing. Market-based pricing links the rate of interest to moves in the market rather than charging a fixed margin above LIBOR/EURIBOR. The margin under market-based pricing is correlated to the likelihood of default by the borrower, based on the cost of buying credit protection against that borrower through a credit default swap at the time of drawdown. The main advantage of this approach is that the margin should more accurately reflect the borrower's creditworthiness and lenders will therefore be more willing to lend to that borrower for a longer period of time. In addition, because the margin is determined at drawdown, the borrower may also benefit from any improvement in market conditions.

Another possible alternative is for both lenders and borrowers to consider reducing interest periods from the standard one-, three- or six-month periods to enable banks to quote rates for shorter periods and for all parties to benefit from the greater liquidity available at shorter maturities.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.