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From LIBOR to SONIA - Technical Adjustment or Substantive Shift?

From LIBOR to SONIA - Technical Adjustment or Substantive Shift?

LIBOR (the London Inter-bank Offered Rate) is at the heart of private funding to the housing sector. Post-2022 however, banks will no longer be required to provide LIBOR quotations and thought needs to be given as to how that may affect Registered Social Landlords who have loans that continue beyond 2022 or indeed are taking out loans now.

Is there a proposed replacement for LIBOR?

The most likely replacement is the Sterling Overnight Interest Average (SONIA) administered by the Bank of England. SONIA is based upon the overnight rate payable on eligible sterling denominated deposit transactions of no less than £25 million.

What are the key differences between LIBOR and SONIA?

These are likely to be as follows:

Backward v Forward-Looking

LIBOR is a composite contributor of banks' responses to the hypothetical question "at what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11a.m. London time?" . This being a subjective decision is amenable to manipulation but does at least fix a rate at the outset of a rollover period allowing the borrower to know how much they will have to pay at the end.

SONIA is based on rates from actual transactions making it difficult to manipulate. However, this means that the borrower will not know how much they have to pay until the end of the interest period with all the uncertainties and other issues that may arise.

Work is currently taking place on products that would allow a SONIA based interest rate to be fixed at the beginning of an interest period. The Bank of England Working Group have identified 6 possible methodologies for doing so but these are still under discussion and review.

Term /Risk

LIBOR is offered for 7 different periods (being overnight, 1 week, 1 month, 3 months, 6 months and 1 year) with longer periods incorporating an increasing premium to compensate for loss of funds and credit risk. As an overnight rate SONIA is effectively risk free which, in the absence of countervailing factors, will give rise to a lower rate and invariably a different rate from LIBOR. Accordingly it is unlikely that a loan at, for example, LIBOR plus 1% would simply be translated to SONIA plus 1%.

Parties will thus have to consider if there are any existing fall-back provisions in their loan agreements and what is proposed in agreements presently being negotiated.

Impact on break costs during either a rollover or more importantly a fixed period may also need to be considered.

Will LIBOR be retained post-2021?

The proposal is that post-2021 LIBOR will be voluntary rather than mandatory and could potentially continue beyond that date.

However, doubts have been raised regarding the appetite of banks to do so given past issues so it may be prudent to proceed on the basis that LIBOR will not continue much beyond 2022 and consider what implications that may have for current and proposed borrowings.

Should you require any further information regarding either LIBOR or SONIA, please contact us.

Written by : TC Young

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