SSAs lead way in bond market evolution

Public sector borrowers are driving the implementation of the new risk-free rates in sterling and dollars, with the former now a widely accepted and mainstream product in fixed income. A group of supranationals and agencies are also working closely with the European Central Bank to revolutionise the issuance and distribution of euro-denominated bonds. Burhan Khadbai reports.

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The European Investment Bank pioneered the move to Sonia-linked issuance with a five year floating rate note in June 2018, in what was the first bond linked to the benchmark since a Bank of England working group chose Sonia (Sterling Overnight Index Average) as the preferred alternative to sterling Libor in 2017. 

A wave of supranationals have followed the EIB in issuing Sonia-linked bonds, including the World Bank and the Asian Development Bank. This year, agencies have also started to issue in Sonia format, including FMS Wertmanagement and Export Development Canada.

“Looking back to this time last year to the EIB Sonia deal, they made sure the process was fool-proof and it set the tone for the others that followed in the SSA space,” says Kerr Finlayson, head of the frequent borrower group syndicate at NatWest Markets in London. “Sonia is very much in the mainstream now and is a widely accepted product in the UK. It’s not just bank treasuries buying it now, but also more central banks and asset managers, as well as accounts from outside of the UK.”

Mark Byrne, a syndicate official at TD Securities in London, says: “As soon as the first few deals went well, it gave all market participants confidence to make the transition to Sonia for their FRN issuance. We started with a lot of issuance in either SSAs or from UK banks in covered bonds, but recently some non-UK banks have begun issuing covered bonds, which is great to see.”

SSAOther developments have followed, with Associated British Ports this year becoming the very first issuer to request that investors change an existing bond’s reference rate from Libor to Sonia. 

While the consent solicitation was small in size — a £65m 2022 FRN — it has kickstarted a transition that could end up involving more than £30bn of FRNs in the sterling bond market.

And it is not just bonds that are making the switch over to Sonia ahead of the 2022 deadline for Libor discontinuation. In July, NatWest Markets and National Rail signed a bilateral loan that was the first to be linked to Sonia from a UK-based corporate.

“The one thing really in Sonia’s favour is that it has been around for some time,” says Finlayson. “Since April 2018, it has been administered and published by the Bank of England. There was also a big push by the Bank of England through the Sterling Risk Free Reference Rate Working Group for Sonia to be the risk-free rate in sterling and a willingness by banks to look at it.”

Byrne says: “There’s not much left to do in terms of the development of the Sonia FRN market. We’ve seen a lot of debut Sonia trades this year and if the levels to issue in sterling were more attractive, we would have seen some more by now.”

Slower Sofr

SSAs have also led the way in the development of the Secured Overnight Financing Rate (Sofr) bond market, with Fannie Mae and the World Bank becoming the first two borrowers to issue Sofr-linked FRNs in the summer of 2018.

But in sharp contrast to Sonia, the Sofr bond market has struggled to gain momentum, with only a handful of issuers following since.

“Everything has been set up from scratch — FRNs, futures markets, swaps trading and all the associated infrastructure,” says Byrne.  “It’s a brand new index that’s only been around for just over a year, so it’s taking time for everyone to get the various systems in place and become familiar with it.”

“The second reason, which very much stems from the first reason, is that there are few natural end users of Sofr at the moment. Bank treasuries don’t really have any underlying use for Sofr in their day to day operations.”

Another stumbling block has been the various structures of issuing in Sofr.

When Fannie Mae and the World Bank issued the first Sofr trades, they used coupons that were calculated as a simple daily average. But when the EIB came to the Sofr market in November 2018, it rewrote the script.

Instead of sticking with a daily average coupon calculation, the EIB instead opted to issue its debut Sofr-linked FRN with a coupon that was compounded over the quarterly payment period, matching the Sonia-linked FRNs and the Sofr derivatives market.

In June 2019, the EIB changed up the methodology once again by using a coupon calculation that did away with the ‘lockout’ period method, which ignores Sofr rates for a set timeframe, and instead uses a five day observation or lag period of Sofr rates.

However, EIB’s latest Sofr deal seems to have caught the eye of market participants as something that could catch on.

“A lot of people were happy with the last EIB deal,” says Byrne. “What we’re trying to avoid is a lockout where fixings are ignored or missed.”

Finlayson says: “With a lookback, if there was a rate hike over that period, investors would have that added on to the next coupon payment. But with a lockout, they would miss out. So purely on this, having a lookback is way better than a lockout.”


There is some precedent suggesting that the EIB’s latest Sofr structured might become the market standard. The coupon method copies the sterling Sonia-linked market, which many in the market now consider to be a standard format of transaction, despite having been around in meaningful volume for only a year.

“It definitely helps to have consistency, but I don’t put [the multiple structures of Sofr] down as the main reason why there is a lack of Sofr issuance thus far,” says Byrne.  “Until recently it was simply the fact that investors weren't Sofr-ready rather than not liking a particular structure. Investors aren’t saying ‘I’m-Sofr ready but I don’t like this particular structure so I won’t be buying this’, for example.”

Nevertheless, a standardised methodology would help with the overall development of the Sofr bond market.

“We have seen that there have been successes with the different structures, but if you want to create the deepest pool of demand, then a standardised approach is the easiest way to do that,” says Kerr.

Ester festering?

Meanwhile, there has been even smaller progress with Ester (Euro Short Term Rate), the recommended new risk-free benchmark for euros after Euribor and its original replacement, Eonia, were both deemed uncompliant with Benchmark Market Regulation (BMR).

“Sterling and dollars are ahead of the pack in terms of the transition from Ibor to the new risk-free rates,” says Byrne. “Having a regulator saying that you have to stop issuing Libor products and look at new alternative risk-free rates really helps the demand for these FRNs.

The ECB will start calculating and publishing Ester rates on October 2, but Euribor is being reformed to comply with Benchmarks Regulation (BMR), so it may remain as a benchmark despite the introduction of Ester. Eonia, however, will be phased out by 2022.“With the other currencies, the picture is less clear, including in euros where Euribor could still remain in place. If that’s the case, the rationale for Ester FRNs is less clear cut.”

Synchronised platform

As well as leading the way in the transition away from Libor, public sector borrowers are also closely involved in a project that could revolutionise the issuance and distribution of euro-denominated bonds.

The European Distribution of Debt Instruments (EDDI) initiative is run jointly by the European Central Bank and the European Stability Mechanism to create a one-stop, synchronised platform for selling euro bonds that handles everything from bookbuilding to settlement right across the eurozone.

SSAThe project, started by the ESM looking for a way to harmonise the pre-issuance aspects of bond sales, found common ground with the ECB, which longed for a unified settlement scheme for the single currency area. Thus EDDI was born — or at least conceived. It is intended though that issuers will be able to use the pre- and post-issuance parts of the system separately if they wish, or indeed, not at all.

But the ESM is not the only public sector borrower closely involved in the project. Since late 2016, the ESM has been holding frequent consultations with four other public sector borrowers, seeking their feedback on the initiative. They are: Bank Nederlandse Gemeenten, the European Investment Bank, KfW and the Council of Europe Development Bank — with the ESM, five of the largest euro borrowers in the SSA bond market.

A six-week market consultation concluded on July 9 and the ECB's governing council is expected to make a decision next year on whether to approve the project. 

“What seems to set the EDDI proposal apart is that it provides an ECB and Eurosystem endorsed institutional pan-jurisdictional bridge,” says Michael Huertas, co-head of law firm Dentons’ European financial institutions regulatory practice in Frankfurt. “EDDI as an infrastructure solution really aims to make the single market more single in the same way that the ECB and Eurosystem has already achieved in the payments area with TARGET-2 and in securities settlement with TARGET-2 Securities.”