The Infrastructure and Projects Authority (IPA) has now published further guidance in relation to the move from LIBOR (The London Inter-Bank Offered Rate) to SONIA (The Sterling Overnight Index Average) for public authorities engaged in PFI Projects (IPA Guidance).
The aim of this note is to set that guidance in the context of the NHS Standard Form Project Agreement (NHS Standard Form) and to summarise what it means for NHS PFI Trusts.
In PFI schemes, LIBOR is used to calculate the cost of debt finance borrowed by a Project Co to fund the development of a PFI project. This flows through to the payment made by a Trust to its PFI partner over the life of a PFI project.
LIBOR is relevant when this payment needs to be adjusted, for example, in variations (where the “no better, no worse” principle applies under Schedule 22 (Variations)). It is also relevant to certain specific provisions of the NHS Standard Form which are heavily influenced by Project Co’s funding costs:
- calculation of default interest (including defaults not leading to termination); and
- the calculation of compensation due on termination (including the calculation of SWAP breakage costs).
The transition from LIBOR to SONIA has been partly driven through a realisation that the former is potentially open to manipulation by the banks that contribute to its calculation. Unlike LIBOR, SONIA is tied to an active and liquid underlying market reflective of the average of the interest rates banks pay to borrow sterling overnight. The Bank of England will administer SONIA and it will closely track its base rate which is comparatively stable and predictable.
This transition means that several changes will need to be made to Project Co’s funding documents (Transition). It is widely expected that public sector counterparties to PFI contracts will be asked to consent to the changes.
LIBOR is not used in most PFI projects that are financed by bonds, so Transition may not be relevant for those projects unless, for example, LIBOR is used as a fallback rate. However, as stated below (see “Variations to the Project Agreement”, below), the NHS Standard Form includes LIBOR as a defined term and the Project Agreement should be checked to assess whether it has been retained or removed for project funding-specific reasons.
The initial guidance published by IPA in February 2021 anticipated that LIBOR would cease to exist after the end of 2021. This would have meant that Transition would need to have been complete by this deadline.
The absence of clarity as to what the replacement (i.e. SONIA) will look like means that it is likely that a short-term alternative to LIBOR (Synthetic LIBOR) will be available beyond the end of 2021 and throughout 2022. The Financial Conduct Authority has issued a consultation on this proposal and a decision will be made before the end of 2021.
In our view, the timings of the IPA Guidance and the length of time that the consent process is likely to take make the use of Synthetic LIBOR in the context of NHS PFI transactions almost unavoidable. However, it is only a temporary measure which postpones but does not avoid the need for a consent process in relation to the adoption of SONIA and lenders will be keen to finalise the Transition as quickly as possible (sometimes with consent being a retrospective requirement).
A copy of the IPA Guidance can be accessed by clicking on the link in the footnote below.
Key points are as follows:
- Trusts should not prompt any changes necessitated by Transition but should wait for Project Co to take the lead.
- The unitary payment should not be affected by any changes Project Co makes in respect of Transition.
- Although the move will fall within the scope of the definition of “a Refinancing”, there should be no refinancing gain resulting from the move to SONIA.
- If Project Co seeks consent from the Trust, the Trust should provide that consent on the basis of the exchange of template letters which have been included in the IPA Guidance. The templates take the form of a letter from Project Co explaining the changes it seeks to make and a response from the Trust, consenting to those changes on the basis of the information contained in the letter from Project Co.
- Consent should be provided promptly and should not be held up as commercial leverage against Project Co in relation to any other commercial issues or disputes.
- Consent should be limited to the question of Refinancing and not to any other issue.
- External adviser costs should be minimal but should be paid for by Project Co if consent is required.
What it means for NHS Standard Form PFI Trusts
Trusts should bear in mind that the IPA Guidance has been drafted on the basis of the Standard PFI Contract issued by HM Treasury (SoPC4). There are differences between SoPC4 and the NHS Standard Form in the context of the Transition which need to be borne in mind.
Clause 4.2 of the NHS Standard Form provides Project Co with flexibility to generally deal with its funding agreements as it sees fit, including agreeing amendments with its funders. This is subject to a number of provisos:
- The changes made should not materially and adversely affect the ability of Project Co to perform its obligations.
- They should not have the effect of increasing the Trust’s liabilities on an early termination.
- Any amendment which constitutes a Refinancing must only be carried out in accordance with the refinancing provisions.
The first two bullet points are common to both SoPC4 and the NHS Standard Form and are referred to in the template letter from Project Co to the Trust seeking consent to the Transition (see paragraph 2.2):
“We do not expect the LIBOR Transition Amendments (i) to have a material adverse effect on the ability of the Contractor to perform its obligations under the Project Documents including the Project Agreement; or (ii) to have the effect of increasing the Authority’s liabilities on early termination of the Project Agreement.”
Although SoPC4 requires Authority consent for a Qualifying Refinancing, the NHS Standard Form requires consent but also provides that, where there is a Refinancing, it must be carried out in accordance with Schedule 29. The template consent letter from the Trust to Project Co may need to be adjusted to reflect this dual requirement.
The IPA Guidance is helpful on this point in that it states:
“…for the vast majority of PFI projects subject to the Transition there should not be a Refinancing Gain within the SPV as a result of the Transition.”
The template letter from Project Co to the Trust seeking consent is clear in that, if it is subsequently discovered that a Qualifying Refinancing has arisen as a result of the Transition, the Refinancing provisions of the Project Agreement will apply.
Although Project Co’s letter to the Trust expresses the view that Transition is not expected to increase the Trust’s compensation liabilities on an early termination (CoT), it does not amount to confirmation that this will be the case. As the IPA Guidance points out, the reason for this is that:
“A major difficulty in determining whether the CoT liabilities have relatively increased or decreased is that, in future, LIBOR will not exist in the same way (either at all or potentially only for a limited period as synthetic LIBOR for tough legacy finance contracts). It will therefore be very difficult to accurately calculate whether any CoT liability change was created by the Transition or not.”
The Trust’s consent letter does not waive the Trust’s ability to challenge increased CoT – this would be an issue which would be postponed for resolution until any subsequent early termination.
Although the IPA Guidance envisages that Trusts could be asked to consent to an increase in the Trust’s future CoT liabilities, the Trust should seek specific guidance from DHSC before providing this consent. The underlying message is that such a request should only be agreed where there is a demonstrable, project-specific reason for doing so.
Timing, Commercial Leverage and Governance
The discontinuation of LIBOR is a decision that has been made by the Financial Conduct Authority. As such, it is something with which PFI funders have had to comply. This means that the IPA Guidance has strongly expressed the view that consent should be provided as soon as possible and should not be used as commercial leverage in relation to other disputes or commercial issues which are not related to Transition.
However, the IPA Guidance also points out that, where there are legitimate reasons for the Trust to carefully consider their position with respect to the Transition, they should do so. This may be the case where the request for consent is more complex than is anticipated by the IPA Guidance.
Governance compliance by the Trust will be essential for Project Co and its funders. Although the nature of the consent letter is such that it could be executed under normal delegated authority, addressing LIBOR references in the NHS Standard Form is likely to need a deed of variation. Trusts should familiarise themselves with the internal governance requirements they should follow under their constitution or standing orders in relation to the execution of deeds.
External Advice and Costs
The IPA Guidance envisages that, for the vast majority of Trusts, the prescribed consent process will be straightforward and will avoid any need for Trusts to incur significant external costs.
There is an acknowledgement that additional advice may be required in relation to a minority of projects which are more complicated or where the consent sought goes beyond the scope of the template letters. In the context of the NHS Standard Form, Trusts also need to bear in mind that Transition may require the Project Agreement to be amended (see “Variations to the Project Agreement”, below) and that additional advice may be required.
Under either circumstance, the IPA Guidance states that where external adviser costs are incurred in respect of the Transition, Trusts should be reimbursed by Project Co.
Variations to the Project Agreement
The IPA Guidance states that there should be no changes to the Project Agreement, unless LIBOR is directly mentioned in which case any direct reference to LIBOR should be amended to the new benchmark interest rate used (ie. SONIA).
Unlike in SoPC4, in the NHS Standard Form LIBOR appears as a definition in its own right as well as in the definition “Default Interest Rate” in Schedule 1 and at Schedule 23 in the definition “No Default Interest Rate”. These definitions will need to be amended as part of the consent process.
What should non-NHS Standard Form Trusts do?
Trusts with project agreements which pre-date the NHS Standard Form should review them to understand the extent to which consent may be required by Project Co. However, even if express consent is not required, we anticipate that Project Co will still seek consent, if only to avoid any liability under the Code of Conduct for the Refinancing of early PFI Transactions, which was published by HM Treasury in September 2002 in order to address the absence of refinancing provisions in many of the early PFI projects.
If this is the case, non-NHS Standard Form Trusts should still frame the consent documents around the terms of the template so that they reflect the limitations of the IPA Guidance.
NHS Specific Guidance
If NHS specific guidance is issued on Transition, this note will be updated.
Trusts are likely to be engaged by their Project Co over the next few weeks for consent to Transition.
If you require support, please speak to your usual Bevan Brittan point of contact. Alternatively, speak to any member of the Bevan Brittan Commercial Health team whose details are set out below.