Sterling Sonia switch within sight
The speed with which sterling sub-sectors have switched their benchmark rate from Libor to Sonia has been astonishing. There’s still some way to go, particularly in the corporate market, but the transition, which looked almost unassailable in 2017, might just be done on time.
The UK, as the host of Libor (and Libor-rigging), has led the transition away from the discredited benchmark.
Andrew Bailey, head of the Financial Conduct Authority, fired the starting gun on the move in July 2017, announcing that after 2021, UK authorities would no longer compel banks to provide submissions to the rate-setting process.
That speech echoed around global financial markets, forcing market participants and regulators from Sydney to Switzerland to start figuring out how to either strengthen interest rate benchmarks, or replace fatally flawed rates based on skinny transaction volumes with stronger offerings.
The push was strongest closest to Libor’s home town, with senior UK regulators repeatedly banging the drum for a quick switch to new reference rates.
The sterling market, fortunately, already had a useable alternative benchmark in the shape of Sonia, the sterling overnight index average — which already had tradeable, relatively liquid derivatives markets associated with it, and even a single bond (EBRD, issued in 2010).
Supranationals moved relatively swiftly to adopt the new approach, with European Investment Bank printing a landmark deal in June 2018. This didn’t quite set the new standard, with EBRD opting for Libor-based floater shortly afterwards — but by autumn that year, after the World Bank’s deal, it was clear few issuers would look to go back.
Covered bonds moved close behind, with Lloyds' inaugural Sonia-linked deal in September 2018 — to be followed by Santander, and a flurry of smaller institutions. Within only a few short weeks, it had become inconceivable for a covered issuer to print a Libor floater.
Securitization markets, with their own regulatory issues to cope with, took a little longer. Specialist lender Paratus printed a Libor deal only last month, while the debut public Sonia deal, Nationwide’s Silverstone, only came at the end of March 2019.
But the same “tipping point” effect kicked in — and the recent flurry of UK securitizations, covering lease ABS, marketplace lending, credit cards, buy to let mortgages, and prime mortgages — are all in Sonia format. The shorter dated asset classes, such as auto loans, may still pay down before Libor formally switches off at the end of 2021, but a precedent has been set, and it would be a bold issuer who prints a new issue in Libor format now.
Corporates, perhaps predictably, are taking longer — but then, relatively few sterling corporate floaters are ever issued. Associated British Ports (ABP), whose treasurer sits on the Bank of England’s risk free rates transition group, has launched a consent solicitation on a tiny £65m 2022, aiming to change the coupon to Sonia, and this may set a precedent for others.
These public market, new issue changes don't mean the market is out of the woods yet.
Issuing new securities on the Sonia benchmark is one thing — but renegotiating legacy Libor linked loans and repapering Libor linked derivatives is another thing entirely. This is difficult, detailed work, which treasurers ought to engage with as quickly as possible, taking guidance, where appropriate, from industry bodies like ISDA and the Loan Market Association. There may be hiccups in hybrid and hedge accounting, and it’s certain to be a time-consuming and data intensive project.
The lesson we can take from public markets and their rapid Sonia switches is that the tipping point, when it comes, comes quickly. The saturation drive from regulators is having an effect in pushing banks and investors to get ready for the switch off. Issuers wanting to change will be welcomed with open arms. For once, the sterling market is all pointing in the same direction.
Although this is no cause for complacency. The best case scenario for the end of Libor is that it looks a little like the “Millennium Bug”, which threatened to collapse computer systems across the world at the end of 1999, as they lacked the digits to represent the new date.
It turned out to be a damp squib, with no real effect — but that was only thanks to months and years of behind the scenes work to prepare. The Sonia switch now, more than ever before, looks achievable — but don’t stop pushing to get there.