With EURIBOR-referencing loans a €1 trillion market, coupled with the lack of significant movement in adopting robust EURIBOR fallbacks in the loan market, it feels like we are in danger of heading towards a potential LIBOR transition 2.0 headache.
Despite clear guidance given by the Working Group on Euro Risk-Free Rates (the Euro Working Group) and the concerted global industry effort to transition away from LIBOR, lessons learned as to the importance of robust fallbacks seem to have quickly been forgotten. This blog flags the risk and explores why market participants need to take action.
What’s the deal with EURIBOR?
Whilst there are no current plans to discontinue EURIBOR, the slow pace of adoption of robust EURIBOR fallbacks in the loan market is cause for concern and sets us up for a potentially disorderly transition should there be a future cessation.
EURIBOR is a significant benchmark. In 2024 alone, new Euro-denominated loans exceeded €1tn with over 1,700 EURIBOR-referencing loans executed (source: Dealogic) – and that figure does not include multicurrency facilities with euro as an optional currency. Apply those figures over multiple years and you quickly build an indication of the volume and number of EURIBOR-referencing loans that may be outstanding at any point in time. Any potential transition exercise would not, therefore, be a small undertaking. Just think, it took seven years to transition away from LIBOR even with advance notice.
So, how can we make our lives easier should EURIBOR cessation ever come to pass? The answer is simple – insert robust fallbacks to your new and refinanced EURIBOR-referencing loans! Of course, there are details to consider around fallback rates and systems, but it is not something that has not been done before.
What fallbacks is the loan market using now?
In many cases, we understand market participants are choosing to stay with the comfort of familiarity of using existing clauses in agreements, i.e. cost of funds and a form of replacement of screen rate language. However, it should be obvious from LIBOR transition that cost of funds is not a robust fallback – the Official Sector, including the Financial Stability Board, have made clear statements on this.
As for replacement of screen rate language (all permutations of it), this is not actually a fallback at all. What this provides for is a method to reduce consent levels for interest rate benchmark amendments. An amendment still needs to be made, so parties would still need to reach agreement – this would likely come at a pinch point where resources would be limited (as we found with LIBOR transition).
For more background on what is and is not a fallback in LMA documentation, see the LMA guidance note published in December 2024 on Fallbacks to interbank term rates: Guidance on LMA documentation.
What should the loan market be using as a fallback for EURIBOR?
For starters, LMA rate switch language. This is the hardwired fallback language produced by the LMA. But what about the EURIBOR fallback rates? The Euro Working Group published recommendations following industry consultation – to put it simply, parties have a choice between compounded €STR and term €STR. These rates are already in existence and available for use and are documented within the LMA’s exposure draft EURIBOR fallback agreements. We know from conversations with the market that there is no clear preference between compounded or term €STR (with parties expressing good reasons for choosing one over the other). It is important for parties to carefully consider the options.
The Italian game – an opening move is made
Rather like the chess opening gambit, the Italians have positioned themselves on the board by being the first EU jurisdiction to mandate robust fallbacks in loan agreements by legislation. Article 118-bis of the Italian Consolidated Law on Banking (which came into effect in January this year) includes an obligation on banks and intermediaries to include within relevant agreements clauses dealing with changes to a benchmark in case it materially changes or ceases to be provided. This has impacted loan agreements, including outside of Italy. For example, English law governed syndicated loan agreements with Italian obligors and international syndicates have had to consider these requirements.
The Italian legislation has had a positive effect in terms of increasing the focus within the loan market on robust EURIBOR fallbacks. The market is already making choices between compounded and term €STR and documenting fallbacks. We are pleased to hear of the use of the LMA’s exposure draft single currency EURIBOR fallback agreements. We were also pleased to receive feedback on the exposure drafts, and interest in implementing robust EURIBOR fallbacks from members across key EU jurisdictions such as France, Germany and Spain.
What this indicates is that anyone now implementing robust EURIBOR fallbacks in loan agreements will not be a first mover – it is already being done. Whilst there may be discrepancies in readiness in the market, which is never a good thing when it comes to syndicated loans – you are only as strong as your weakest link – market participants are already moving and those not looking at implementation will get left behind.
Why take action if EURIBOR is still here?
Aside from the clear statements of the Official Sector across the globe to focus on robust fallbacks and potentially applicable legislative requirements, let’s not forget that we all took LIBOR for granted – look at where that got us. It is far better to take control, prepare and make decisions on robust fallbacks when there is time to think about them, rather than be rushed into a position at a point of urgency.
The positive for everyone is that there is nothing particularly new here to get your head around – the fallback rates and rate switch architecture are very much in line with what we went through for LIBOR transition (and for which documents and systems were created). The only real difference is that we are talking about fallbacks rather than transition – however, the same principles apply.
Whilst it may be tempting to take a laissez faire view that there will be enough time so we can kick the can down the road, this is a tactic wide open to risk. Even though authorities would look to give notice of any cessation, this logic did not prevent LIBOR transition involving a herculean effort by the market. Another factor to consider here is the increase in the use of euro in project finance, export finance and development finance – these loans come with significantly longer tenors than corporate loans which make the need to deal with potential EURIBOR cessation far more tangible.
The Official Sector has clear expectations that the market should heed the lessons of LIBOR transition and focus on robust fallbacks to reduce the legacy stock at the point of any transition and avoid creating an unnecessary and potentially painful LIBOR transition 2.0. In addition, other markets have already moved to robust fallbacks, including the derivatives market. The loan market risks being left behind.
But what about the CAS?
Rest assured, the credit adjustment spread (CAS) has been thought about and there are no surprises here – the Euro Working Group has recommended the same methodology as that adopted by ISDA, i.e. the 5-year historic median approach. Bloomberg is in fact already publishing indicative spreads and the LMA has also produced a drafting rider for the CAS.
Where do we go from here?
Given the importance of robust fallbacks to financial stability, the LMA set up a EURIBOR Fallbacks Task Force last year to help drive implementation in the market. We also continue our dialogue with the Official Sector.
Following feedback received from the market on the LMA’s exposure draft single currency EURIBOR fallback agreements and their use in the market, the LMA will shortly be moving these to recommended forms. This wording will then be implemented across the LMA euro-referencing suite to ensure that all LMA documents include robust EURIBOR fallbacks. LMA recommended forms for both compounded and term €STR fallbacks should help encourage adoption.
What is clear is that the loan market needs collectively to move towards robust EURIBOR fallbacks. Whilst EURIBOR is not scheduled to be discontinued, what nobody wants is for the loan market to walk wilfully into a LIBOR transition 2.0 scenario. t’s up to market participants to make a choice: act now to ensure the market is well prepared or kick the can down the road and risk a disorderly cessation. We know which one we would choose.
If you are interested in learning more about the EURIBOR Fallbacks Task Force and the work of the LMA on EURIBOR fallbacks, contact kam.hessling@lma.eu.com.
