LIBOR Transition: Sovereign Borrowing

On 5 March 2021, the UK Financial Conduct Authority (FCA) announced that the publication of LIBOR on a representative basis will cease for LIBOR settings as follows:

• For overnight, 1-month, 3-months, 6-months and 12 months US dollar LIBOR settings, immediately after June 30, 2023; and
• For all euro, sterling, Swiss franc and yen LIBOR settings, immediately after December 31, 2021.¹

Euribor is not affected by this announcement.

The International Swaps and Derivatives Association confirmed that the announcement by the FCA will result in the fallback spread adjustment under the IBOR Fallbacks Supplement and the ISDA 2020 IBOR Fallbacks Protocol being fixed at the date of the announcement for all LIBOR settings. When the panels for all US dollar LIBOR settings cease after the end of June 2023, fallbacks for all outstanding derivatives of adhering counterparties will automatically shift to near risk-free rates plus the spread adjustment that has now been fixed.²

On 23 March 2021, the Alternative Reference Rates Committee (ARRC) announced that it will not be in a position to recommend a robust forward-looking Secured Overnight Financing Rate term rate by mid-2021, and that it cannot guarantee that it will be able to do so by the end of 2021. The ARRC encourages all market participants to continue to transition from LIBOR using the tools available now. Read more

In October 2020, the Board of Directors approved a Board paper on preparing for the reference rate transition of ADB’s sovereign loans. The paper included the following principles that ADB adopted to guide its decision-making when transitioning to a new reference rate:

1. follow a market-based approach and be informed by a market-dominant transition paradigm to the extent it emerges and is compatible with ADB’s other guiding principles;
2. maintain the well-established cost pass-through principle;
3. offer uniformity and treat all borrowers the same; and
4. ensure transparency.

ADB is monitoring market developments and the building of market consensus and is closely coordinating with other multilateral development banks on the reference rate transition.

Management will seek Board’s guidance on the financial product that will replace the LIBOR-based loan product with alternative reference rates in the first half of 2021.

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In July 2017, the United Kingdom’s Financial Conduct Authority announced it will no longer compel banks to submit rates for the London interbank offered rate (LIBOR) beyond 2021, signaling that the survival of LIBOR in its current form “could not and would not be guaranteed”. As a result of this announcement, financial regulators worldwide have been strongly encouraging financial institutions exposed to the LIBOR reference rate to prepare for its replacement before the end of 2021. Across jurisdictions, regulators are promoting national currency-specific alternative reference rates. For United States dollar-denominated loans and securities, the recommended new benchmark is the Secured Overnight Financing Rate.

1. What is LIBOR?

London interbank offered rate (LIBOR) is the most widely used benchmark for short-term interest rates. LIBOR is currently available for five currencies (US dollar, pound sterling, euro, Swiss franc, and yen) and for seven tenors in respect of each currency (overnight or spot next, 1 week, 1 month, 2 months, 3 months, 6 months, and 12 months). Although its origins date back to 1969, it was not formalized until the British Bankers' Association began overseeing the collection and governance of the data nearly 2 decades later. LIBOR has played a critical role in global markets; it has been widely used as a reference rate for financial contracts and as a benchmark to gauge funding costs and investment returns for a broad range of financial products, including adjustable-rate mortgages, credit cards, floating-rate bank loans, and interest rate or cross-currency swaps. It is estimated that globally, more than $300 trillion financial contracts are currently benchmarked on LIBOR.¹

2. What are the issues with LIBOR?

The methodology for calculating LIBOR has remained largely unchanged since it was introduced. Each day, a group of large banks, known as “panel banks”, report their funding rates to the Intercontinental Exchange Benchmark Administration, which took over administering LIBOR in 2014. Those numbers are averaged, adjusted, and released at about 11:55 a.m. London time each business day.

There are two main concerns with this process: first, there has been a significant decline in the sample size for calculating LIBOR since the 2008 financial crisis. In its aftermath, fewer panel banks have been reporting, and those that do, report fewer quotes based on market transactions. Instead, LIBOR has increasingly relied on what the Intercontinental Exchange Benchmark Administration calls "market and transaction data-based expert judgment." Therefore, concerns were raised about how well LIBOR reflects market realities since it is not based on actual market transactions. Second, LIBOR’s reliance on inputs from panel banks opened it to manipulation, and there have been a range of irregularities uncovered by regulators, which have led to large fines for those involved. As a result, global regulatory initiatives have sought to develop alternative reference rates (ARRs). In the United States (US) dollar market, for example, the US Federal Reserve commissioned the Alternative Reference Rates Committee (ARRC) in 2014 to recommend a benchmark interest rate to replace US dollar LIBOR.

3. What is the timeline for phasing out LIBOR?

In July 2017, the Financial Conduct Authority (FCA), which regulates the administrator of LIBOR, announced that it will no longer compel panel banks to participate in the LIBOR setting process after 2021. Since then, the FCA has indicated that (i) all global market participants should assume that there will be no LIBOR publication after 2021; (ii) even if LIBOR were to continue beyond 2021, it would have fundamentally changed; and (iii) markets for LIBOR-related contracts are likely to be illiquid, and the ability to hedge outstanding LIBOR obligations is likely to be impaired. Therefore, global market participants with LIBOR-linked financial products must prepare to shift to ARRs by 31 December 2021.

4. What Is ADB’s exposure to LIBOR?

ADB is exposed to LIBOR across various financial modalities. The most significant is the LIBOR-based loan product, which is ADB’s main sovereign lending product. ADB offers its borrowers LIBOR-based loans with a floating rate of interest based on the 6-month LIBOR, plus an effective contractual spread and, where applicable, a maturity premium fixed over the life of the loan. The cost base rate is 6-month LIBOR for US dollar and yen, and 6-month Euribor for euro-denominated loans. The cost pass-through principle, in which the funding cost for borrowings raised to fund the loan portfolio is passed on to borrowers, is followed. The funding cost and lending rates are computed by calculating the average funding cost margin below (rebate) or above (surcharge) the relevant benchmarks in each currency for all borrowings funding the loan pool of the same currency during the previous semester. Rebates and surcharges are announced twice a year, for the periods 1 January to 30 June and 1 July to 31 December and are applied to individual loans on the interest payment date following the announcement date. Loans may be made on a floating-rate basis in other foreign currencies in which ADB can efficiently intermediate, and such loans may reference another relevant floating rate benchmark, as applicable. ADB is also exposed to LIBOR through swaps and derivatives that ADB enters into to hedge interest and currency risks of its borrowing transactions and borrowers’ preferences for certain interest rate structures and currencies. LIBOR-based loans are typically funded by ADB with borrowings raised at a fixed rate of interest that are swapped to a floating rate of interest based on LIBOR to match the reference rate of the LIBOR-based loans.

ADB also issues across various currencies to gain cost efficiencies and typically swaps the receipt of these currencies into US dollar. In addition, local currency loans are also frequently funded through cross-currency swaps from US dollar LIBOR into the local currency benchmark. As of 31 December 2019, ADB is exposed to LIBOR for US dollar and yen, and Euribor for euro-denominated loans through sovereign loan operations, nonsovereign loan operations, swaps and guarantees across two currencies, the yen and US dollar, with the vast majority to the US dollar.

5. What benchmarks are available after LIBOR phases out?

For US dollar-denominated loans and securities, the ARRC recommended the Secured Overnight Financing Rate (SOFR) as the new benchmark. It is calculated based on transactions in the US Treasury repurchase market, where banks and investors borrow or lend US Treasury securities overnight. The US Federal Reserve began publishing SOFR in 2018.

The reference rate used for Asian Development Bank’s (ADB) loans in euro, the Euro Interbank Offered Rate (Euribor), has been reformed. In July 2019, the reformed Euribor was found to be compliant with the European Union Benchmark Regulations and continues to be used, but the euro LIBOR may cease to be published after 2021. The Euro Short-Term Rate is the new benchmark recommended to replace the Euribor and the euro LIBOR should either reference rate cease. In addition to Europe, Australia and Japan are also pursuing a multiple-rate approach to benchmarks, where reformed reference rates will continue for the foreseeable future alongside the development of recommended ARRs. Notably, across currencies and jurisdictions, regulators promote their own currency-denominated ARRs based on short-term lending, and these vary in composition. Table 1 provides an overview of selected major currencies for which ARRs have been identified and recommended by public and private sector working groups in those jurisdictions.

Table 1: Alternative Reference Rates for Sovereign Loans

Country	LIBOR–IBOR	Alternative Reference Rates	Public or Private Sector Working Groups	Description
United States	US Dollar LIBOR	SOFR	Alternative Reference Rates Committee	Secured rate that covers multiple overnight repurchase market segments
Japan	JPY LIBOR, TIBOR, and Euroyen TIBOR	TONAR	Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks	Unsecured rate that covers overnight call rate market
Europe	EUR LIBOR and Euribor*	ESTR	Euro RFR Working Group and European Money Markets Institute	Unsecured rate that covers the overnight wholesale deposit transactions

AONIA = Australian dollar Overnight Index Average, BBSW = Bank Bill Swap Rate, ESTR = euro short-term rate, EUR = euro, Euribor = Euro Interbank Offered Rate, GBP = pound sterling, IBOR = Interbank offered rate, JPY = Japanese yen, LIBOR = London interbank offered rate, RFR = risk-free rate, SOFR = Secured Overnight Financing Rate, SONIA = Sterling Overnight Index Average, TIBOR = Tokyo Interbank Offered Rate, TONAR = Tokyo Overnight Average Rate, US = United States.

Note: A secured rate is collateralized by funding transactions which serve as security. For example, SOFR is collateralized by funding transactions secured by US Treasury securities. An unsecured rate is not collateralized. In Australia, BBSW is expected to continue to exist alongside AONIA. Source: Morgan Stanley Research.

6. What are the key differences between LIBOR and the Secured Overnight Financing Rate?

Although SOFR and LIBOR both reflect short-term borrowing costs, there are key differences. First, SOFR relies entirely on transaction data, whereas LIBOR is based partially on market-data “expert judgment." Second, SOFR is so far only available as a daily rate (i.e., an overnight rate), whereas LIBOR is quoted with varying rates on forward terms of 1 day to 1 year. Finally, LIBOR incorporates a built-in credit-risk component because it represents an uncollateralized cost of borrowing by a bank. In contrast, SOFR represents a risk-free rate because it is based on interbank trades and collateralized by funding transactions secured by US Treasury securities.

Table 2: Key Differences

SOFR	LIBOR
Relies entirely on transaction data from over $700 billion daily repurchase transactions.	Is based partially on market-data and partially on expert judgment.
Measures the cost of collaterized borrowing overnight based on interbank trades and secured by US Treasury securities.	Measures the cost of uncollaterized borrowing in the interbank market and incorporates a built in credit-risk and liquidity component.
A backward-looking rate, published daily.	A forward-looking rate, published daily, with term rates from 1 day to 1 year.

7. How will a suitable ARR for ADB be determined?

The official sector and public and sector working groups in each of the five currencies for which LIBOR is produced have identified and recommended ARRs and are now actively supporting the transition towards their use. The working groups in each of the five currencies for which LIBOR is produced have identified ARRs to replace LIBOR as follows: SOFR for US dollar, SONIA for pound sterling, €STR for euro, SARON (Swiss Average Rate Overnight) for Swiss franc, and TONAR for yen.

The working groups support of the transition towards the use of ARRs assists the development of markets and is expected to build liquidity in ARRs. For example, the depth of SOFR derivatives markets is growing but is currently still small relative to LIBOR. A major catalyst for derivatives markets growth is expected in October when central clearing parties begin to discount using SOFR. The adoption by clearing houses to move to SOFR price alignment interest and discounting on new and legacy swaps and the adoption by swap counterparties of the International Swaps and Derivative Association IBOR Fallbacks protocol later this year will assist the transition.

Market consensus on the use of ARRs is still emerging in the loan markets. ADB follows market developments to better understand the building of market consensus, particularly around conventions in the use of SOFR in loans.

There is no certainty that a forward-looking term SOFR will emerge. Recent communication from the ARRC notes that: “While it is true that a forward-looking SOFR term rate may be appropriate for a limited set of contracts, the growth in SOFR-linked futures, swaps, and floating-rate debt demonstrates the current viability of using SOFR itself in a wide range of financial contracts. A robust forward-looking term rate requires a deep, active SOFR derivatives market, which requires most financial contracts to reference SOFR itself. It is essential that most financial contracts reference SOFR itself as soon as possible, to develop a forward-looking SOFR term rate, and in turn facilitate a smooth transition. Since March 2020, the New York Fed has been publishing SOFR Averages for several tenors and an index to calculate SOFR rates over custom time periods. These provide a transparent and reliable source that market participants can use to start building new SOFR-linked contracts now. There is currently not sufficient underlying futures activity to support a robust term rate and no assurance that one will be produced ahead of LIBOR becoming unusable.” The ARRC recommends that market participants that can use SOFR should not wait for forward-looking rates to transition away from LIBOR.

Once there is more certainty to the transition path in the loans market, ADB will act in a timely manner and prudently review how best to adopt the new dominant market paradigm.

8. What principles will ADB consider when ADB decides on ARRs?

ADB will use the following four principles to decide on ARRs:

(i) Market-based approach. ADB will review the latest developments in the market and inform borrowers about them, highlighting any consensus building around certain approaches. In particular, if the majority of market participants adopt a certain transition approach that meets ADB’s other principles described below, ADB will carefully review the approach and consider the adoption of such a market-based paradigm. An example of such an approach would be the expected fallback language to be issued by the International Swaps and Derivatives Association in July 2020, which will set out revised terms to be included in new derivatives and an industry-wide basis to contractually amend and include the same terms in existing derivatives. Since most market participants are expected to follow the International Swaps and Derivatives Association-led interbank offered rate reforms, ADB is highly likely to follow such a market-dominant paradigm for the transition of its swap contracts.

(ii) Cost pass-through principle. ADB’s cost pass-through principle for sovereign loans has been enshrined in its financial policies for decades. Thus, it will also serve as the guiding criterion for determining ARRs. In particular, the conversion of LIBOR-based borrowing costs into ARRs will be translated in an equitable manner so that ADB does not systematically gain or lose as a result of the conversion.

(iii) Uniformity. All borrowers will be offered exactly the same approach and transition arrangements, i.e., no borrower should systematically gain or lose from the transition at the expense or to the benefit of other borrowers.

(iv) Transparency. To ensure maximum transparency, ADB will fully disclose calculations and analyses related to ARRs and applicable spreads to borrowers and the Board.

9. What is ADB’s proposed approach for transitioning sovereign loans?

The current OCR Loan Regulations are not sufficient to protect ADB and borrowers from potential losses in a situation when LIBOR ceases. If LIBOR ceases and ADB cannot agree on an alternative for calculating the floating rate of interest with each borrower, the OCR Loan Regulations apply a three-step determination process to try and calculate the floating rate of interest. Ultimately, the most recent calculated LIBOR rate will be applied for the current interest period. Repeating this process for each interest rate fixing will complicate hedging and may lead to asset−liability mismatches.

Furthermore, the current OCR Loan Regulations are not sufficient to protect ADB and borrowers from potential losses in a situation when LIBOR is declared no longer representative. There is a risk that LIBOR is no longer representative of the underlying market it seeks to measure but is still published. Where a reference rate is still published, the OCR Loan Regulations apply the reference rate, but it may not be representative of the cost of funding. This will undermine the cost pass-through principle.

The OCR Loan Regulations require an amendment to address an uncertain LIBOR transition path and to avoid potential losses for ADB and borrowers. ADB proposes to amend the OCR Loan Regulations to broaden the circumstances in which the reference rate can be replaced and enable ADB to determine ARRs in a timely manner. For existing loans, such a change in agreement will require the borrowers’ consent.

10. What timeline does ADB considers for the LIBOR transition?

ADB will engage borrowers through an outreach to inform them about ADB’s transition approach and to provide market information on LIBOR transition to borrowers. Consultations with borrowers will assist in the finalization of the Recommendation paper which will be presented to the Board of Directors in October 2020. If the Recommendation paper is approved, the revised OCR Loan Regulations will be made applicable to new loans. For existing loans, ADB will seek such a change in agreement with borrowers’ consent. Following the Recommendation paper discussion in October 2020, management aims to seek the Board’s guidance on the financial product that will replace the LIBOR-based loan product with new ARRs and the financial policy issues associated with the transition process in the first half of 2021.

11. What rules apply to nonsovereign loans?

The template for nonsovereign loan agreements of the Asian Development Bank is based on industry-recommended form documentation that provides a three-step determination process when the LIBOR ceases to be published: (i) using an interpolated screen rate, (ii) polling major reference banks, and (iii) applying ADB’s own cost of funds as the final fallback. The documents also provide for negotiating a substitute basis for determining the reference rate with the borrower.

12. How will ADB cooperate with other multilateral development banks in this area?

ADB and other multilateral development banks (MDBs) have agreed to collaborate and share knowledge and best practices on the reference rate transition. MDBs are committed to working together and sharing information throughout the transition period. While there may be differences in approaches because of the unique characteristics of each organization's loan portfolio, the structure of loan products, and the terms and conditions for reference rate replacements, MDBs will coordinate as much as possible to make the transition process easier and smoother for their borrowers. In particular, ADB is coordinating closely with the World Bank, which is also the designated MDB representative in the ARRC.

13. How was Euribor reformed and why was LIBOR not reformed in the same way?

The Euribor is the reference rate that ADB’s uses for its loans in euro. Euribor underwent a reform process over the past few years to reduce the risk of market manipulation and to align with European Union Benchmark Regulation requirements. The governance framework was strengthened, and a hybrid calculation methodology was developed based on a quantitative assessment and panel bank’s judgement. Two public consultations related to the hybrid calculation methodology took place between March 2018 and February 2019, which concluded that the methodology was adequate in terms of market representativeness. In July 2019, the reformed Euribor was found to be compliant with the European Union Benchmark Regulations and will remain to be used.

While LIBOR has undergone several reforms, including moving from a quote-based methodology to a transaction-based methodology, a lack of adequate interbank market activity means it remains at risk of no longer being representative of the market it seeks to measure.

14. What will be the benchmark that will replace JPY LIBOR

The publication of LIBOR in any currency, including JPY LIBOR cannot be guaranteed beyond the end of 2021. The Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks has recommended TONAR replace JPY LIBOR. Japan is pursuing a multi-rate approach to interest rate benchmarks, where reformed TIBOR will continue for the foreseeable future alongside the development of recommended ARRs.

15. Where can information on SOFR be found?

ARRC publishes materials to explain SOFR and the transition. Below are ARRC best practices and a SOFR starter kit.

¹ For example, A. Bailey in his most recent speech related to Libor referenced that “These are rates which directly impact the cash flows and values of an estimated $400 trillion of financial products globally”. A. Bailey. 2020. Libor: Entering the Endgame. Speech delivered by the Governor of the Bank of England, London and New York. 13 July

SOFR Starter Kit

History and Background

• Background on USD LIBOR
• History of the ARRC and the selection of SOFR

Key Facts About SOFR

• How SOFR works
• SOFR by the numbers
• Common misconceptions of SOFR

SOFR Next Steps

• SOFR best practices
• Recommended fallback language
• The user’s guide to SOFR
• Helpful tools from the ARRC

  LIBOR Transition Frequently Asked Questions

Introduction

1. Why were the OCR Loan Regulations revised?

In anticipation of the discontinuation of LIBOR, on 26 July 2021 the ADB Board of Directors approved the Flexible Loan Product (FLP) to replace ADB’s LIBOR-based loan product. It was then necessary to revise the Ordinary Operations Loan Regulations Applicable to Regular Loans Made from ADB’s Ordinary Capital Resources (OCR Loan Regulations) to give effect to the FLP. In addition to LIBOR related changes, the ADB Board approved the introduction of a floor of no less than zero for ADB’s interest rates to provide clarity should negative interest rates occur and enhancements to strengthen the debt monitoring and reporting of borrowers and guarantors, which have also been reflected in OCR Loan Regulations (2022).

2. Why were the Ordinary Operations (Concessional) Loan Regulations, Special Operations Grant Regulations and Externally Financed Grant Regulations revised?

Subsequent to the approval of the OCR Loan Regulations (2022), corresponding enhancements to the debt monitoring and reporting requirements were incorporated into the Ordinary Operations (Concessional) Loan Regulations (COL Loan Regulations), Special Operations Grant Regulations and Externally Financed Grant Regulations.

3. When will the OCR Loan Regulations (2022), COL Loan Regulations (2022), Special Operations Grant Regulations (2022) and Externally Financed Grant Regulations (2022) apply?

The OCR Loan Regulations (2022) superseded the OCR Loan Regulations (2017), the COL Loan Regulations (2022) superseded the COL Loan Regulations (2017), the Special Operations Grant Regulations (2022) superseded the Special Operations Grant Regulations (2017), and the Externally Financed Grant Regulations (2022) superseded the Externally Financed Grant Regulations (2017). These loan and grant regulations became effective on 1 January 2022 and are made applicable to all new OCR loans, COL loans and grants under ADB’s sovereign operations approved on or after 1 January 2022. Existing loan and grant regulations will continue to apply to OCR loans, COL loans and grants approved before 1 January 2022. Following the current practice, the new loan and grant regulations will be incorporated by reference in the loan, guarantee, and grant agreements for all such loans and grants.

4. What are the changes?

The OCR Loan Regulations (2022):

• introduced changes necessary to implement the FLP;
• formally reflected the “floor” of no less than zero for ADB’s interest rates; and
• introduced enhancements to strengthen debt monitoring and reporting by borrowers and guarantors.

The COL Loan Regulations (2022), Special Operations Grant Regulations (2022) and Externally Financed Grant Regulations (2022) introduced enhancements to strengthen debt monitoring and reporting by borrowers, guarantors and recipients.

LIBOR Related Changes

5. What are the LIBOR related changes?

Under the new FLP, the Secured Overnight Financing Rate (SOFR) and the Tokyo Overnight Average Rate (TONA) replace the London Interbank Offered Rate (LIBOR) as the reference rate used in determining a floating rate of interest for regular loans denominated in US dollars and yen respectively.

Other LIBOR related changes are mostly technical, administrative and operational in nature and include:

• removing definitions that are no longer applicable, such as “Banking Day”, “Financial Centre”, “LIBOR”, “London Banking Day”, “Reference Rate Reset Date” and “Target Settlement Day”;
• introducing new definitions such as “SOFR” and “TONA”;
• revising other definitions such as “Reference Rate” and “Relevant Rate Page”; and
• revising the conventions for day count fractions used for SOFR and TONA, and the timing for determining interest rates as the “Reference Rate Reset Date” is no longer applicable.

6. Are the LIBOR related changes similar to ADB’s peers?

The LIBOR related changes are consistent with market practice and aligned with relevant multilateral development banks (MBDs). ADB followed a market-based approach to determining alternative reference rates as recommended by the relevant working groups, the Alternative Reference Rates Committee and the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks. ADB also aligned the modifications to its LIBOR-based loan product and the terms of the OCR Loan Regulations (2022) with those of IBRD and AIIB, who were identified as the market for MDB sovereign lending in Asia and the Pacific.

7. How does the definition of “Reference Rate” provide for alternative reference rates?

The definition of “Reference Rate” now provides for SOFR and TONA. The definition also reflects that the applicable Reference Rate may be specified in the loan agreement (e.g., if the loan is in a local currency) or changed upon a loan currency conversion.

8. How have the day count fractions been decided on?

ADB followed a market-based approach to the day count fractions it will use when calculating interest using alternative reference rates. The Alternative Reference Rates Committee recommended Actual/360 for SOFR-based loans, which is the standard day count convention used in US money markets. The Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks recommended Actual/365 for TONA-based loans to maintain consistency with TONA.

Changes Related to Interest Rate Floor

9. Why was the zero floor introduced?

The OCR Loan Regulations (2022) include a zero floor in interest to formalize the existing treatment of negative interest rates. The zero floor clarifies that if negative interest rates occur, the interest for regular OCR loans under sovereign operations shall not be less than zero.

10. How will the zero floor be calculated?

The calculation of interest is set out in Article III of the OCR Loan Regulations.

Section 3.02 Interest (a) of Article III of the OCR Loan Regulations (2022) provides, “[f]or each Interest Period, interest shall be calculated at the Floating Rate, as such rate may be modified from time to time in accordance with the provisions of Article V; provided, however, that the interest calculated in accordance with this Article for any Interest Period shall in no event be less than zero.” [Emphasis added.]

The zero floor therefore will apply to the aggregate of interest calculated in accordance with Article III, which consists of the Reference Rate and Fixed Spread (Section 3.02(a)), credit (Section 3.03(b)), maturity premium (Section 3.03(c)), rebate (Section 3.06(b)) and/or surcharge (Section 3.07(b)). It does not apply to commitment fees, prepayment premium, or front-end fees (applicable only to Contingent Disaster Financing loans) as these are not part of interest under Article III.

Changes Related to External Debt Monitoring and Reporting

11. What are the changes?

The changes are (i) a representation by a ADB’s Developing Member Country (DMC) borrower, guarantor, or recipient that it has not defaulted on any of its debt, other than as disclosed to ADB, at the time of the signing of a new loan or guarantee agreement; (ii) a representation by a DMC borrower and/or guarantor on the existence of liens on the assets of the borrower/guarantor as security for foreign currency debts, other than as disclosed to ADB, at the time of signing of a new loan or guarantee agreement; and (iii) an obligation on a DMC borrower and/or guarantor or recipient to provide information, on ADB’s reasonable request, in relation to the financial and economic conditions in the DMC.

12. Who is required to give the two representations and when will they be given?

Both representations form part of the OCR Loan Regulations (2022) and COL Loan Regulations (2022) and will therefore be incorporated by reference in each loan and guarantee agreement (not in a separate document). The representation on no default on debt also forms part of the Special Operations Grant Regulations and Externally Financed Grant Regulations. As such, the 4 representations will be made by the DMC (through its representative, e.g., Ministry of Finance) on the date of the loan, guarantee, or grant agreement by virtue of it being signed. This approach is consistent with the approach takenby IBRD and IDA.

13. Why does ADB’s representation on “no defaults” cover both domestic and foreign currency debt?

ADB’s representation covers defaults on any debt (i.e., foreign and domestic debt) because, when it comes to the financial health of ADB’s DMC borrowers and guarantors, visibility over the DMC’s defaults under its local currency debts is just as important as visibility over defaults under its foreign currency debts.

14. What are the implications of the requirement to provide information on the DMC borrower’s/guarantor’s financial and economic condition upon ADB’s reasonable request?

This requirement to provide information on the DMC borrower’s/guarantor’s financial and economic condition upon ADB’s reasonable request is included in all loan and grant regulations. Reinstatement of this requirement that existed in 2001 OCR Loan Regulations is helpful should ADB need any specific economic or financial information that is outside the scope of routine project-level work, to address any particular concerns that may arise in the future. This requirement relates directly to enhanced debt monitoring, reporting and transparency by the DMC borrowers and guarantors. A similar requirement is found in the regulations/conditions of ADB’s peer MDBs.

15. What is the negative pledge clause (NPC) requirement?

As part of the sovereign lending legal framework, the NPC enables ADB to provide loans to its borrowers without taking security. NPC is a prohibition on the establishment of a priority for other debts over the debt due to ADB. ADB should not be less protected than other creditors by being subordinated to other creditors’ debts. NPC is not a prohibition on Public Private Partnership or other forms of project financing in general. Pledging of assets are permissible so long as such pledges do not involve the assets of the DMC or ADB is provided with pari passu rights or an equivalent lien. The scope of NPC is limited to foreign currency debt for a DMC borrower/guarantor.

16. What are the changes on NPC?

The changes to the NPC in the OCR Loan Regulations (2022) and COL Loan Regulations (2022) include (i) providing clarity on the purpose of the NPC requirement; and (ii) distinguishing the NPC applicable to a borrower and/or a guarantor who is a DMC (scope covers liens with respect to foreign currency debt) from one applicable to a borrower who is a non-member (scope covers liens with respect to any debt). These changes make the NPC requirements more closely aligned with the approach of peer MDBs, but do not change the fundamental principle of the NPC as it has historically been applied by ADB.

  Q&A Revised Loan and Grant Regulations