The Impact of the Phasing out of LIBOR on Aviation Transactions
On November 30, 2020, the Intercontinental Exchange Benchmark Administration (“IBA”), the administrator of U.S. Dollar LIBOR (“USD LIBOR”), announced that it intends to cease publication of 1 week and 2 month USD LIBOR rates at the end of 2021 and it intends to cease publication of the remaining USD LIBOR tenors on June 30, 2023.
This announcement followed an earlier IBA announcement on November 18, 2020, that all GBP, EUR, JPY, and CHF IBOR tenors would cease publication after December 31, 2021.
This has implications for aviation transactions, given that most cross-border aircraft transactions are USD denominated.
The New York Fed’s Alternative Reference Rates Committee (ARRC) has recommended that USD LIBOR is going to be replaced by the Secured Overnight Financing Rate (SOFR). Marking a shift in soft regulatory control from London to New York – and resulting from certain unfortunate occurrences in London in the past decade.
The main issue arising for commercial parties is the risk of currency and product divergence
While the international consensus is that existing LIBOR rates should be replaced by risk-free rates (“RFR”s), independent working groups in the jurisdictions of the major currencies for which LIBOR is provided have taken responsibility for developing the replacement RFR for their domestic currency. This means there will no longer be a common benchmark rate for different currencies, as currently available through LIBOR for USD, GBP, Euro, CHF and JPY. As airframes and aviation engines are USD valued assets, many aircraft leases and loans are USD denominated and use USD LIBOR as their benchmark rate (expressly, in the case of a floating rate loan or lease; or, for leases with fixed rentals, implicitly within the underlying lease rate calculation).
It is expected that specialist aviation financiers and operating lessors will follow the USD syndicated loans market in adopting SOFR in order to simplify the LIBOR transition for the aviation market but lenders and lessors should be sensitive to the likelihood that airlines with domestic currency ticket sales, debts and other non-USD denominated cashflows will still be formulating their entire LIBOR transition policy, including for currency hedging arrangements. The position may be further complicated where their domestic currency is pegged to the US dollar. In other cases, the relevant benchmark rate for a currency may be continuing, as is the case with EURIBOR (as distinguished from Euro-LIBOR) which is frequently used for Euro-denominated loans and other products. The derivatives, loans and bonds markets have also diverged in their approaches to calculating replacement RFRs and to setting the timing and mechanics for such replacement, with differing optionality within the relevant documentation.
Commercial parties and their advisers need to be keenly aware of the commercial implications of these ongoing developments for specific transactions and for the positions of the market participants. Any negotiations between commercial parties must take these developments into account. The documentation of agreements also needs to carried with an eye on these developments.
NPL Legal will continue to monitor these developments in order to provide our clients with the most up to date and cogent advice.
