The London Interbank Offered Rate (LIBOR) is being replaced by the end of 2021. Joseph Carr, Director at Aqulia Treasury Finance Solutions, suggests ten top tips for housing associations to manage the transition effectively.
19 December 2018
Since the global financial crisis, LIBOR has been discredited as the reference for measuring interbank borrowing, because of some banks’ involvement in rigging the rate-setting process. Also, transaction volumes on which rates are calibrated have fallen dramatically.
Although LIBOR underpins $350tn of global commercial financial transactions – some $30tn of which is in the UK, including circa £60bn English housing association loans and £10bn standalone derivatives – it is no longer regarded as fit for purpose, and is to be replaced by SONIA (Sterling Overnight Index Average) by the end of 2021.
SONIA will need to be adopted in loan agreements and derivative deals. The transition to SONIA will not only affect the pricing of new transactions but will also affect existing financial instruments that mature after 2021. This is particularly significant for housing associations, as they hold a disproportionately high volume of long-dated instruments.
As SONIA tracks below LIBOR, there will need to be a recalibration exercise on transition, and rates could diverge after that point. Therefore, the transition may not be economically neutral and, as the process is market-led, the fear is that funders may not adopt a consistent approach. Additionally, there is a concern that the wording of new and existing lending agreements may allow funders to unilaterally amend terms.
Substituting current SONIA rates for LIBOR in existing English housing association facilities suggests potential increased exposure in excess of £1bn for the sector. Housing associations need to ensure they are preparing for this change now to assess and limit the extent of the potential impact.
Top ten tips to reduce the exposure to your organisation
1. Be sure to keep abreast of changes as the new system is being developed, and to tap into market-led initiatives.
At the end of last month, The Bank of England issued a helpful starter pack on the transition to SONIA. It contains helpful links to essential reading and a timeline with important milestones up to implementation.
2. Consider collaborating with fellow housing associations that hold similar financial instruments and work through the different options for transitioning to SONIA.
By understanding the implications for individual housing associations, a more comprehensive appraisal of the impact on the sector should emerge. These can then be channelled through the National Housing Federation, to the BoE and Financial Conduct Authority, amplifying the message.
3. Review existing loan and derivative portfolios to:
- identify those which mature after 2021
- quantify the potential impact
- determine whether they contain clauses that protect the interests of borrowers.
4. Ensure you future-proof new financial instruments, either by denominating them in SONIA or referencing to SONIA elements maturing after 2021.
5. Seek professional advice early, from your treasury adviser or legal representative. The transition to SONIA is a very complex process.
6. Once you have assessed the impact as suggested above, notify your board of the estimated impact and agree contingency arrangements.
7. Include the transition to SONIA on your organisation’s risk register – assess the risks and benefits and agree mitigation for a range of scenarios.
8. Agree governance arrangements, including allocating the responsibility for SONIA to a senior executive.
9. Decide on an approach and timing for negotiating with funders.
10. Most importantly – do not panic...
It is not certain how exactly this will pan out but following these tips will stand your organisation in a strong position to navigate the changes successfully. The credit crunch exposed weaknesses in the operation of global money markets, and the transition from LIBOR to SONIA, whilst potentially being bumpy, may well result in a system which is more robust and stable.