The transition from LIBOR to SONIA

The ongoing move from LIBOR to SONIA, scheduled to be completed by the end of 2021, will affect housing associations that borrow from banks or other financial institutions.

Housing associations have borrowed in excess of £70bn from banks and other financial institutions in the last 30 years to build homes and deliver thriving communities. Around one third of this debt is variable, benchmarked to the London Inter-Bank Offered Rate (LIBOR), and the majority have terms in excess of 10 years. However, at the end of 2021 the banks will stop reporting their LIBOR information and LIBOR, in its existing form, will cease to exist.  

Because of this, the Risk Free Rate Working Group convened by the Bank of England and the Financial Conduct Authority (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 – compounded in arrears rate

The compounded in arrears rate is now deemed to be the best approach to developing the first margin step. The International Swaps and Derivatives Association (ISDA), the trade body for derivatives, has set out that this is its favoured approach, therefore to enable hedging to continue the loan market would have to follow this approach.

In lieu of this, the RFRWG recently consulted on publishing an index on the compounded in arrears rate that should enable smaller organisations to make use of this rate. We responded to this consultation.

Following this consultation, the Bank of England has announced it will publish a compounded index from August 2020 – read more about about how this will work in practice.

Step 2 – the credit adjustment spread

The RFRWG consulted on the Credit Adjustment Spread in early 2020. This will determine what should make up the spread between LIBOR and SONIA in cash products, in a fair way. We responded to the consultation supporting the approach previously taken by the ISDA.

National Housing Federation work

As well as responding to the above consultations, we held a meeting in October 2019 with the Bank of England, the FCA, 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 NHF 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 NHF to increase communication to leadership teams and board members on this change.

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

Housing association work

A joint statement by the Bank of England, FCA, ACT and CBI, ‘Calling Time on LIBOR: Why you need to act now’, outlines a four-point plan for immediate action:

1. Establish where your LIBOR exposures are

  • Mortgages, loans, deposit facilities, derivatives and floating rate notes may reference LIBOR. It can also be found in ancillary contract terms (leasing and servicing contracts), company pension schemes, commercial contracts and discount rates used in valuations. It is important to identify your exposure to LIBOR and to understand what will happen to these contracts if LIBOR is no longer available.

2. Check your contract terms

  • Your contracts may include “fallback” terms setting out what will happen when LIBOR is not available. However, these terms often do not envisage that LIBOR could be permanently unavailable. Check the fallback terms, what that means for your financial product and whether they need to be amended.

3. Familiarise yourself with SONIA, and what it means for you

  • In sterling, the overnight rate SONIA is an alternative benchmark to LIBOR. SONIA is not a like-for-like replacement for LIBOR and cannot be directly substituted into existing contracts. Given the differences between the two rates, your organisation may need to make changes to systems in order to use SONIA.

4. Speak to your bank, product provider, consult with a financial services professional or advisor

  • Ask your bank what preparations they are making and what that means for your organisation. You can seek further advice from financial service professionals as you consider how to prepare for transition.

We are advising all housing associations to include the transition to SONIA on their risk registers and to ensure that boards are fully aware and understand this issue.

Useful links and resources

Who to speak to

John Butler, Policy Leader