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Better the devil you know – The move from LIBOR to SONIA

No, unfortunately this article is not about the 1980s pop princess Sonia but the rather more mundane (but crucial) imminent replacement of LIBOR as the base benchmark rate in many loans in the social housing sector.

You may already have noticed in funder term sheets that pricing going forward is not calculated by reference to LIBOR, or your funders may have already started dialogue with you about updating existing loan agreements to reflect changes.

To recap, the London Interbank Offered Rate (“LIBOR”) is a global interest rate benchmark used by many UK funders and has been the interest rate benchmark of choice for many UK corporate borrowers, since the 1980s.

Due to fears of LIBOR being subject to manipulation, often arising from the 2008 liquidity crisis, it became less credible as a benchmark rate. The validity of LIBOR was further questioned by a significant reduction in inter-bank lending. The move away from LIBOR was actively encouraged by the Financial Conduct Authority and the Bank of England, and LIBOR will cease to be the key interest rate benchmark for sterling by the end of 2021, with no new LIBOR products being offered to the market after the end of March 2021.

What are the alternatives?

Lenders are currently faced with the decision of whether to:

  1. explore other proposed “risk-free” rates (“RFRs”);
  2. switch to Bank of England Base Rate;
  3. only offer fixed rates to their corporate borrowers; or
  4. explore other pricing mechanisms.

A number of proposed RFRs were considered as a replacement to LIBOR and the Sterling Risk-Free Reference Rate Working Group recommended the use of the Sterling Overnight Indexed Average (“SONIA”) as the most suitable replacement for LIBOR in the UK. Several funders to the sector are now setting terms based on SONIA, although others have moved exclusively to other options such as those detailed above.

What is SONIA?

The Bank of England administers and publishes SONIA based on very short-term unsecured loans among and between UK financial institutions, which reflects the average of the interest rates banks pay to borrow sterling overnight from other financial institutions and institutional investors.

The most significant difference between SONIA and LIBOR is how each is calculated. SONIA is an “overnight rate” and can only usually be calculated on a “backwards-looking” basis using historical overnight rate data at the end of that period, whereas LIBOR is a “forward-looking” term rate which is fixed at the beginning of an interest period. There are plans to develop a forward-looking SONIA rate as a funding basis.

Another change is that break costs should in theory no longer be required for SONIA loans (as they are for LIBOR loans), as loans will no longer be priced against a forward-looking interest rate benchmark.

How will changes be affected?

Existing funding agreements expected to extend beyond March 2021, which do not incorporate interest rate benchmark fallback provisions (often referred to as “replacement of screen rate” clauses) will have to be amended. This can be achieved with an amendment agreement between the relevant parties, to incorporate either SONIA or a new agreed pricing mechanism e.g. Base Rate or fixed rate etc. It is likely that even existing agreements that incorporate replacement of screen rate will need amending, due to the complexity of the transition. Loan agreements incorporating the Loan Markets Association replacement of screen rate wording have as a key component that any change will, so far as possible, be cost neutral to both lender and borrower, which is obviously a key consideration.

In the absence of a formal replacement of screen rate mechanism, borrowers will be governed to some extent by the amendments provisions in the underlying facility agreement, which will confirm whether the lender can affect the change in rate at its sole discretion, or whether they will require borrower consent.

New funding agreements and heads of terms will now detail a non-LIBOR linked pricing mechanism option be that SONIA, fixed rate, Base Rate or perhaps an alternative RFR. Borrowers will need to ensure that the mechanism chosen is understood and the pricing can be benchmarked at the outset.


Your key contact

Fraser MacRae


Fraser represents both lenders and borrowers on secured and unsecured financing and advises on a mixture of loan agreements, note purchase agreements and other funding structures together with associated security documentation and intercreditor arrangements.
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