Sonia benchmark makes its debut in the loan market

LONDON, July 8 (LPC) — UK transport group National Express has tapped NatWest for the first corporate loan referencing the British Pound (Sonia) overnight index average, a milestone as the market shifts from Libor to alternative risk-free rates (RFR).

Sonia’s lending is currently limited to bilateral facilities, as banks are not yet ready to move away from the current forward-looking three-month Libor rate, and many borrowers are still in the early stages of adopting the new reference.

“We cannot syndicate loans until banks are ready – this will require operational adjustments and modification of loan functions. We’ve seen a lot of movement over the last 9-12 months because banks need to be able to do this,” said a senior banker.

The National Express loan is the first bilateral loan linked to Sonia under a pilot program managed by NatWest. It applies Sonia using a daily compounding, with a five-day reset lag to give a more transparent, data-driven benchmark. This methodology has already been used in the sterling floating rate note market.

The loan market has until the end of 2021 to move away from the Libor benchmarks, which are widely used to compare interest rates on syndicated loans, bonds and derivatives as well as intercompany loans and loans. other types of commercial contracts.

Libor rates fell into disrepute after banks were found to be manipulating rates, and were subsequently fined billions of dollars. Regulators have pushed to replace Libor with substitute rates based on real transactions less open to market abuse.

The UK’s Financial Conduct Authority (FCA) recently called on banks to accelerate the transition from loan products that use Libor as a benchmark rate.

Although lending market participants favor a forward-looking Libor-type term rate, it has proven difficult to develop an acceptable term rate methodology free of speculative elements. Sonia’s retrospective rate stole a march, despite potential issues with cash management and loan back-office functions.

“Financial markets have already seen an initial shift to Sonia as the benchmark rate, such as the bond amendment recently made by Associated British Ports (ABP),” said Bhavin Shah, head of Libor transition for commercial banking at NatWest.

Last month, UK port operator ABP became the first bond issuer to switch from a Sonia-based coupon to a Libor-based coupon on an existing bond. The £65 million (US$81.33 million) floating rate note due 2022 switched to Sonia compounded daily from June 26. NatWest was the solicitation agent for this transaction.

NatWest’s pilot program, which offers bilateral Sonia-linked loans to large corporations, is expected to launch in the wider market in the second half of 2019, once lessons learned from the project are incorporated.

COMPLICATIONS

Issuance of the first Sonia-based syndicated loan could take some time as banks will need to agree on an acceptable market-wide benchmark and also implement the new processes required for the various interest rate calculations. interest.

“It’s one thing to have a bilateral loan linked to Sonia, but it’s another to have a largely syndicated multi-currency revolving credit facility with a large group of international banks,” said a senior banker.

While some larger companies with more sophisticated financing processes may be able to accommodate compound rates, many borrowers might find it extremely difficult to switch to a retrospective rate.

Borrowers are used to a pre-determined, forward-looking variable rate payment structure that allows them to predict their financing costs in advance. They will also have to adapt their systems to accommodate a retrospective rate, which could be costly and time-consuming.

For lenders, Libor rates compensate banks for providing longer-term funds. Although a compound rate may give a term rate, it is still based on the overnight rate and does not reflect the increased risk of lending longer.

Since the pricing, documentation and administration of syndicated loans are also currently based on forward-looking forward rates, banks need to make significant operational changes to make the transition.

Different risk-free rates are being developed for different currencies and are in different stages of development, adding to the complexity of the situation.

But either way, borrowers and banks will have their part to play in the transition.

“Developing the Sonia loan market not only requires financial institutions to develop their products accordingly, but also requires companies to be innovative in their approach and embrace the changes related to Sonia,” said Simon Jenkins, Senior Director of corporate coverage at NatWest. ($1 = 0.7992 pounds) (Editing by Tessa Walsh)

Priscilla C. Carnegie