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Progress on transitioning to SONIA

The Risk-Free Rates Working Group (RFRWG) published an update on the impact of COVID-19 on the timeline for firm’s plans to transition away from GBP LIBOR on the 29th April. While the central assumption of LIBOR’s publication being ceased after the end of 2021 remains intact, the Working Group has amended the timeline for the transition of sterling cash markets. There are resource constraints as a result of the current crisis; as such, the regulatory authorities recognise that the loan market would require additional time to ensure smooth transition. The additional time will be required to avoid compromising an effective flow of credit to the real economy.

The initial deadline for lenders to cease issuing new LIBOR-linked loans has been extended to Q1 2021- instead of Q3 2020 as was originally planned. By the end of Q3 2020 lenders should be adequately prepared to issue SONIA-referenced products to their customers and, after the end of that quarter, to ensure to include contractual provisions for LIBOR products that mature after 2021. These provisions should be met by implementing a fallback language that references SONIA or other non-LIBOR alternatives, coupled with a proactive collaboration between lenders and their borrowers.

These date amendments take into account the resource constraint imposed on firms due to the pandemic; they also aim to ensure a smooth flow of credit to the economy during these times of market stress. Notably, the business interruption loan scheme given by the UK government includes loans that are mostly linked to GBP LIBOR with relatively few benchmarked-on SONIA. Apparently, most of the market participants were not ready to facilitate liquidity “linked” on SONIA yet, and thus the timeline was amended by the RFRWG.

The loan’s market may remain an issue which was already lagging behind prior to COVID-19 with only a few SONIA linked loans issued (such as the five year credit facility between Lloyds Bank and UK social housing provider, Riverside; or the real estate loan signed between Deutsche Bank and Kennedy Wilson, a real estate investment company). In response to that, the Working Group emphasised on the importance of delivering its workplan. That included calculating fair credit spread adjustments in legacy cash products and communicating with participants to help them move away from LIBOR on time.

Despite the loan market transition deadlines being extended, there are still concerns in the market. This is due to the business loan scheme revealing the unprepared participants but also increasing the stock of legacy contracts linked to GBP LIBOR. Looking to the future, market participants need to devote resources to begin accommodating SONIA linked cash products., This includes system upgrades to facilitate interest payments from compounded in-arrears, rather than forward looking rates.

Pauline Pélissier

Director - Financial Services consulting

Pauline is a Director within Mazars’ dedicated UK Financial Services Consulting team. She has more than 10 years of experience in financial services and is an expert in Market Risks and Capital Investment Banking. She started her career as an external auditor in France in 2007. Since then she has been leading on-site teams on statutory audit and consulting assignments in banking (CIB, Project Financing, Consumer Financing, ALM). She was the engagement senior manager for global systemic French banks. As an expert on financial instruments she supports assignments dealing with valuation policies, governance and process for financial instruments, risk measurement methodologies and framework, and risk management.

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