A conventional switch in time.

Last week the Bank of England’s Working Group on Sterling Risk-Free Reference Rates (RFR WG) published a long-awaited document on recommended market conventions for SONIA Loans. This document should have been published earlier this year but was interrupted both by COVID, and the ARRC’s equivalent publication of conventions for syndicated business loans. Much like London Buses, the industry has waited some time for key documentation to support the transition and two have arrived at once!

The Bank had been consulting with the industry on the appropriate conventions. At the beginning of 2020 it seemed that the GBP issuance market had settled on a 5-day lookback without observation shift for SONIA. However, some subsequent issuance used observation shift following a trend in the SOFR issuance market. (With the lookback observation methodology only the observation is shifted back whereas with the observation shift methodology both the observation and the day-count are shifted). The clear consensus from the consultations was for consistency and it seems that we are starting to see such consistency across the recommendations.

The RFR WG recommends SONIA compounded in arrears and a 5-banking day lookback without observation shift. This aligns to the ARRCs recommendations and is also in line with the early releases from the loan system vendors. The intention is clear, to provide a standard convention which participants will be able to deliver in good time. The RFR WG revised recommendations on timelines state that by Q3 2020 lenders should be a position to offer non-LIBOR linked products to customers. The statement of recommended conventions supports this.

In a clear nod to the impact of COVID, the challenges of lenders being fully capable to offer and borrowers being willing and capable to borrow on a SONIA basis, the working group provides a get out of jail free card. The second recommendation on timelines is to include clear contractual arrangements in any LIBOR referencing loan products to facilitate conversion ahead of end-2021. This is above and beyond fallbacks and seeks to ensure that where LIBOR is still chosen over SONIA there are clear switch mechanics to actively transition ahead of cessation. This is somewhat different to the ARRCs hard-wired fallback approach but may well leave the documentation at a similar standard.

Since the statement on timelines was made in April of this year there has been no standard documentation on these contractual arrangements. In late August, the LMA provided a Revised Replacement of Screen Rate Clause which will meet the RFR WG recommendation. It is short and sweet but to the point. Simple drafting allows the clause to be slotted in to other standard documentation. It provides the mechanics by which the parties can agree the terms of active conversion from LIBOR to SONIA. It is more an amendment approach than hard-wired. However, readers may note the BAT facility which had hard-wired terms together with flexible timing.

These two pieces of the puzzle coming just one week apart and as we approach the end of Q3 provide the industry with the tools to begin using SONIA more in lending products.

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