Guidance note issued by Infrastructure and Projects Authority – February 2021
This is a brief summary of guidance issued in February 2021 by the Infrastructure and Projects Authority (IPA), the government’s centre of expertise for infrastructure and major projects concerning the discontinuation of LIBOR. The guidance is available here and is relevant to authorities who have operational, project-financed PFI or PPP contracts.
Some authorities may feel it prudent to bring the guidance to the attention of their financial advisors. However, the guidance makes clear that there is nothing that an authority is required to do at this stage, other than be aware of these changes and understand how they may impact the Special Purpose Vehicle (SPV) party. Indeed, the guidance explicitly states that authorities should not direct their contractors to take any particular course of action – the reason for this is discussed below.
What do authorities need to know?
- LIBOR (London Interbank Offered Rate) is being discontinued with effect from the end of 2021. The discontinuation is likely to impact the vast majority of PFI projects in the UK and many PPP contracts.
- As a reminder, in PFI/PPP contracts, LIBOR is widely used as the base cost of private sector debt finance that is loaned by banks to SPVs, to which is then added the funder’s profit margins (and other fees). This base cost forms part of the Unitary Charge paid to the SPV by the authority. LIBOR is also relevant to operational period events, including variations, refinancing, termination provisions and other finance related provisions.
- The proposed replacement is a new benchmark interest rate called SONIA – the Sterling Overnight Index Average In contrast to LIBOR, SONIA is based on actual historic transactions and reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions and other institutional investors. The key differences between the two are:
- SONIA looks backwards (a measure of overnight borrowing costs), whereas LIBOR looked forward (expectation of rates).
- LIBOR rates are published at several different maturities, whereas SONIA is (currently) only published as an overnight or spot rate without incorporation of a term element.
- Whilst SONIA (like LIBOR) is an unsecured rate, it operates as a near proxy for a risk-free rate because it is a measure of overnight borrowing costs and does not incorporate bank credit risk (which LIBOR does). As such, SONIA is expected to be lower than its LIBOR equivalent.
- It is expected that SONIA will be implemented for PFI/PPP transactions as “an appropriate and robust alternative to LIBOR”. However, it is ultimately a matter for the PFI/PPP private sector investors and their funders to determine the most appropriate alternative benchmark interest rate for PFI/PPP contracts.
How will this affect authorities?
- The switch to SONIA is likely to be considered a general change in law, but not a qualifying change in law (unless the authority mandates a course of action, see paragraph 8 below). The switch would also not constitute any type of compensation event / relief event or other ‘excusing cause’. It may also meet the definition of a refinancing under the finance documents and could, therefore, theoretically give rise to a refinance gain or loss. However, as the guidance explains, while SONIA is expected to be a slightly cheaper rate, refinance gains (to be shared with the authority) are not expected because (i) any gains for the SPV should be countered by equivalent losses under their existing interest swap arrangements, and (ii) the SPV will incur costs (such as legal fees for the amendments of contractual documents).
- Other than amendments to financing documents, there should not be any changes required to the Project Agreement. Administrative costs incurred as a result of these changes should be borne by the SPV and the funders – authorities should not contribute to meeting SPV or other costs as a result of the discontinuation of LIBOR.
- It is also possible that a refinancing event will crystallise liabilities of the SPV under its existing swap arrangements, and such liabilities may threaten the solvency of the SPV. In such circumstances, the authority will need to be made aware as soon as possible and understand the consequences. The IPA is expected to issue further guidance on this later in 2021, once an accepted market protocol has been developed.
What do authorities need to do?
- The guidance advises that there is no immediate need for authorities to do anything other than be aware of the changes and consider how they may impact the SPV. However, the guidance also advises:
- It may be prudent for authorities to discuss with the SPV what its plans are, to ensure that the SPV and the funders are taking appropriate steps to manage any residual risks; but
- To avoid a transfer of risk to the authority, authorities should not mandate or direct a course of action to the SPV. It is for the SPV and its funders to address the change and manage associated risks.
This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published. If you would like further advice and assistance please contact us today by telephone or email firstname.lastname@example.org
 The UK Industry Working Group has recommended that lenders should not offer new LIBOR loans from 1 April 2021.
 LIBOR is not used for bond-financed or corporate-financed projects so such projects may not be impacted.