SONIA starting to replace LIBOR?


Darren Bustin, Head of Derivatives

19 June 2018

Yesterday saw the announcement by the European Investment Bank (EIB) that it would mandate a panel of investment banks to explore the opportunity of launching a GBP benchmark Floating Rate Note (FRN) linked to SONIA in the near future. Whilst it is not unusual for the EIB to issue FRNs, this is the first potential issuance of FRNs linked to the SONIA rate, rather than the traditional LIBOR rate, in approximately 10 years.
As well publicised, LIBOR, as a ‘benchmark interest rate’, is expected to cease by the end of  2021 in the UK in the wake of the LIBOR scandal and the recommendations from the Financial Stability Board to adopt ‘Risk Free Rates’ rather than interbank interest rates which reflect bank credit risk. Following the recommendation of the Bank of England’s Working Group on Sterling Risk Free Reference Rate, LIBOR will be replaced by SONIA, the Sterling Over Night Index Average, as the market’s preferred Risk Free Rate. SONIA was chosen as a replacement reference rate since it is calculated based upon actual market volumes whereas LIBOR was submitted based upon ‘expert opinion’ using trades as an input to the process. 
Transition arrangements from LIBOR to SONIA in the run-up to 2021 are still being worked on by various industry working groups, despite the end date of LIBOR being announced by the FCA. This has led to a rise in uncertainty regarding LIBOR-based financial instruments and as such we were not surprised to see an issuer explore the issuance of SONIA based FRNs ahead of the 2021 deadline. 
RLAM expects this to become a near-term trend, as more and more companies seek to fund using SONIA rather than LIBOR-based instruments, given the near-term uncertainties and the transition away from LIBOR. In the longer term, we expect the issuance of new LIBOR-based FRNs to cease and for it to become the norm for FRNs to reference SONIA in the GBP FRN market. 
Given this will be a new transaction type we will monitor developments and subject to pricing and market conditions may participate in purchasing SONIA-based FRNs in the future.

Yesterday saw the announcement by the European Investment Bank (EIB) that it would mandate a panel of investment banks to explore the opportunity of launching a GBP benchmark Floating Rate Note (FRN) linked to SONIA in the near future. Whilst it is not unusual for the EIB to issue FRNs, this is the first potential issuance of FRNs linked to the SONIA rate, rather than the traditional LIBOR rate, in approximately 10 years.

As well publicised, LIBOR, as a ‘benchmark interest rate’, is expected to cease by the end of  2021 in the UK in the wake of the LIBOR scandal and the recommendations from the Financial Stability Board to adopt ‘Risk Free Rates’ rather than interbank interest rates which reflect bank credit risk. Following the recommendation of the Bank of England’s Working Group on Sterling Risk Free Reference Rate, LIBOR will be replaced by SONIA, the Sterling Over Night Index Average, as the market’s preferred Risk Free Rate. SONIA was chosen as a replacement reference rate since it is calculated based upon actual market volumes whereas LIBOR was submitted based upon ‘expert opinion’ using trades as an input to the process. 

Transition arrangements from LIBOR to SONIA in the run-up to 2021 are still being worked on by various industry working groups, despite the end date of LIBOR being announced by the FCA. This has led to a rise in uncertainty regarding LIBOR-based financial instruments and as such we were not surprised to see an issuer explore the issuance of SONIA based FRNs ahead of the 2021 deadline. 

RLAM expects this to become a near-term trend, as more and more companies seek to fund using SONIA rather than LIBOR-based instruments, given the near-term uncertainties and the transition away from LIBOR. In the longer term, we expect the issuance of new LIBOR-based FRNs to cease and for it to become the norm for FRNs to reference SONIA in the GBP FRN market. 

Given this will be a new transaction type we will monitor developments and subject to pricing and market conditions may participate in purchasing SONIA-based FRNs in the future.

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.