An update on the LIBOR to SONIA transition

Ahead of the switch from LIBOR to SONIA we provide a further update on the transition, including the work that the Federation is doing, and how to bridge the gap for three-month LIBOR contracts.

After the end of 2021, the Financial Conduct Authority (FCA) expect panel banks to depart from the voluntary agreement that provides for LIBOR submissions, and LIBOR, in its existing form, will cease to exist.  

Because of this, the Risk Free Rate Working Group (RFRWG) that has been convened by the Bank of England and the FCA recommended that a different benchmark rate, the Sterling Overnight Index Average (SONIA), would replace Sterling LIBOR. New debt is now being written that benchmarks to SONIA, but not, as far as we know, within our sector.

Bridging the gap for three-month LIBOR contracts

Housing associations’ existing variable rate debt typically references predictive LIBOR (which is set in advance of the interest period), and SONIA is an overnight risk-free rate quoted daily. There is therefore a mismatch between the benchmark that is referenced in housing associations’ current loan agreement documents and SONIA.

There are two steps that need to be agreed before housing associations can move to a SONIA rate that reflects three-month LIBOR in existing contracts:

Step 1 – whether a term rate or a compounded in arrears rate should be applied

Step 2 – what a credit adjustment spread should be based on

Step 1 – term rate or compounded in arrears rate

Three benchmarking organisations are developing term rates for the market by early 2020.

However, a term rate may not be the best answer for replacing LIBOR with SONIA. There is a strong recommendation for a compounded in arrears rate to be used in place of a term rate as there are a number of key benefits to using a compounded in arrears rate above a term rate:

The term rate is likely to be temporary and it is therefore unclear how long this rate may be in existence (it has been suggested that this could be a viable rate for only 15 years). Considering the terms of many housing associations’ loans this creates a distinct disadvantage to using this rate to part replace LIBOR.

The term rate will be less robust than SONIA as it will be based on many fewer transactions than SONIA. Also, the benefit of compounding may mean such rates are less volatile than a forward-looking term rate polled from market transactions on a single day.

The International Swaps and Derivatives Association (ISDA), the trade body for derivatives, has already agreed to use compounded in arrears rates in derivative fallbacks. This means that hedging may be possible in future, if other elements in the SONIA to LIBOR margin align.

Step 2 – the credit adjustment spread

The RFRWG has launched a consultation that will determine what should make up the spread between LIBOR and SONIA in cash products, in a fair way. The NHF will be responding to this by the deadline (6 February 2020) and will engage with the sector in January 2020.

National Housing Federation work

The NHF held a meeting in October 2019 with the Bank, the Financial Conduct Authority, the Social Housing Regulator, UK Finance, lenders' lawyers and the majority of LIBOR lenders in the sector.

In attendance for most of the lenders at the meeting were not only their heads of social housing but project leads on the LIBOR transition and/or an individual with responsibility, or at least part responsibility, for approving changes to existing lending agreements.

The meeting was therefore an opportunity for the Federation to set out the beneficial impact that the sector has on society including how we support the most vulnerable people in our country and deliver one third of all new homes.

An update on the transition process was provided by the co-chairs from the RFRWG’s sub-working group on the Term Rate Task Force.

The lenders provided feedback to the Bank and the FCA on improving the communication of the transition and for the Federation to increase communication to leadership teams and board members on this change.

The meeting has helped to provide the NHF with some comfort on lenders' intentions with the transition and we are working to identify any gaps in this assurance.

Housing association work

We are advising all housing associations to include the transition to SONIA on their risk registers and asking them to understand what happens to their loans and derivatives when LIBOR stops being published by reviewing loan agreements, hedging documentation and any other contracts that may include LIBOR, such as leases, supplier agreements or any other contracts.

We would also encourage housing associations to talk to your lenders and to ensure that your board is both fully aware and understands this issue.