Interest rate: What interest rate?

Now that LIBOR in all forms is no longer being published, what happens if there is an outstanding agreement in your archives which still refers to USD LIBOR or Sterling LIBOR as the benchmark rate used for the calculation of interest? Could interest be calculated some other way? Or could the agreement be terminated on the basis that an essential provision is unworkable?

The test case

These were the issues before the High Court in London in the case of Standard Chartered Plc v Guaranty Nominees Limited and others [2024] EWHC 2605 (Comm), the first case of its kind on the issues under the Financial Markets Test Case Scheme (The Financial Markets Test Case Scheme facilitates the resolution of market issues, or which authoritative English law guidance is needed.)

The Court in this case effectively replaced the contractual USD 3-month LIBOR rate with an alternative reference rate following the end of the publication of LIBOR and the regulators’ instructions to financial institutions to stop using LIBOR as a benchmark rate. This “implied term” was arrived at through technical analysis by the Court, looking right back at the original purpose of, and methodology of preparing, LIBOR. It also considered the long process of reform within the changing parameters set by regulators in the US, namely the Alternative Reference Rate Committee (ARRC). ARRC issued its closing report in November 2023 and the final synthetic LIBOR rates ceased in September 2024.

The result: 3-month CME Term SOFR, plus an adjustment spread was implied by the Court as the alternative rate.

Standard Chartered had tried to have the interest rate provision amended to take account of the LIBOR reforms, but it had not managed to achieve the level of consent needed to do so.

CME Term SOFR

CME Term SOFR is one of the “nearly Risk Free Reference Rates” (RFRs) used to replace LIBOR. It is a daily forward-looking reference rate published by CME Group for 1, 3, 6 and 12-month tenors for USD, and has been endorsed by ARRC. It is almost incredible that at one point during the market discussions for reform, ARRC was considering not having a forward-looking term rate at all and only using daily SOFR on a compounded basis as the approved reference rate.

Adjustment Spread

To compensate for any possible discrepancy between LIBOR and SOFR, the market came up with a credit adjustment spread (CAS) which could be applied on top of published SOFR rates to be used for legacy contracts. The calculation in the Standard Chartered case related to the calculation of interest, after 30 January 2017, on Preference Shares which had been issued by Standard Chartered Plc as part of its Tier 1 capital to comply with its regulatory capital requirements in 2006 (this form of capital was then recategorised as Tier 2). Therefore, as a legacy contract switching from LIBOR to SOFR, it was quite reasonable for the Court to consider including the CAS. The published ISDA Spread Adjustment was used as part of the implied term to create the replacement interest rate calculation. (For new RFR based facilities agreements, the pricing could now include any adjustment, and a CAS may not be listed as a separate element of the interest rate calculation.)

Business sense

The Court considered that the implied term was necessary to provide business efficacy. The term itself, of course, had to be capable of clear expression. Both elements were needed to render the clause for calculation of interest workable. However, the Court also had to consider whether the term itself was essential under the principles of contract law. It held that it was a non-essential term and therefore the remedy of termination was not open to the other parties. This way interest on the Preference Shares could be calculated using the alternative reference rate.

Future disputes and market reaction

There are likely to be some “legacy contracts” in the market which were not amended under any “LIBOR repapering” exercise within the applicable timetable suggested by regulators in the US and the UK. This could be because parties did not engage with the market changes, or the amendment process was unsuccessful or out of time.

We expect that the judgment in this test case will be viewed with some relief now that the Court has taken a pragmatic and business approach to finding and applying an alternative rate, rather than allowing the underlying contract to be terminated. Whether cases reach the courts, settle, or are dealt with by arbitration, from now on there is at least some measure by which parties could anticipate the result if a case did reach the Court on the same question.

We cannot categorically say at this stage what the English courts would imply as an alternative rate for 3-month sterling LIBOR. Could it be 3-month Term SONIA plus credit spread adjustment? What does seem likely is that, through the use of the Financial List at the Commercial Court at the Business and Property Courts, judges will take the time to consider the process and outcome of the LIBOR reforms in the context of alternative rates for particular currencies, and look to apply the business efficacy test, where possible. 

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