SONIA transition: the time for action is now

Have all the big issues been solved?

The results of the Bank of England’s (BoE) ‘compounded SONIA’ consultation published in June settled the last big issue when it confirmed the index method for calculating SONIA-in-arrears:

• The ‘backwards shift observational lag’ is settled: five days is the norm unless mutually agreed otherwise; and
• The adjustment spread between Libor and SONIA is also settled: the calculation is based on a historical five-year median consistent with the International Swaps and Derivatives Association (ISDA); fortunately, it will be published by Bloomberg daily for each Libor period.

Aside from being compounded daily, SONIA involves a peculiar ‘lag’ period, so understandably the change can look daunting. Frankly, the methodology is complex – but from next month, the BoE will make life a little easier by publishing a daily compounded SONIA index as the definitive method for checking interest payable.

The index method works fine for calculating interest payable but it is not workable for accounting periods that end on a weekend or a bank holiday. Despite representations, the BoE decided that it isn’t going to provide the missing data and so borrowers will sometimes need to interpolate the correct accrual. (It’s complicated, but the methodology is clear and Abovo Consult and 2TIX have jointly developed a standalone calculator that plugs this final gap.)

Last September, the Loan Market Association issued “exposure draft” wording for compounded SONIA facilities agreements; this is now in a position to be finalised.

Legislation was rumoured, can we wait?

Without legislation, the transition process will be time consuming. 

The US equivalent to the RFRWG is seeking new legislation to engineer a standard process of transition in New York. UK legislation is being brought forward to strengthen Financial Conduct Authority (FCA) powers to deal with “tough legacy” issues, but will only cover contracts that genuinely have no realistic prospect of renegotiation, and it isn’t without risk. In the announcement chancellor Rishi Sunak reinforced the importance of transition away from Libor by mutual consent.

The conventional way to amend a loan is by side letter, drawn up by legal advisors, and for the borrower to pay for it. Negotiation can become protracted because lenders have a tendency to ‘update’ a loan when any side letter is required. Without the excuse of SONIA transition, lenders would have no other grounds to require changes. The immense scale of SONIA transition suggests that if lenders attempt to expand the scope, it risks the transition getting bogged down.

SONIA transition is an industry-wide change where the contentious issues have been resolved, so borrowers picking up the lender’s costs would be unfair.  

ISDA’s approach is informative; a supplement to the ISDA definitions will incorporate SONIA transition protocol with no other changes. Although not compulsory, swap clearing houses have already indicated that they will use their powers to standardise the implementation of the SONIA transition in all cleared derivatives.  

This won’t help for converting loan facilities to SONIA but illustrates that the swaps market is keen on standardisation.  

A standardised approach is called for here, too. Helpfully in June the Fixed Income, Currencies and Commodities Markets Standards Board issued a good practice guide that specifically covers market conduct and transparency for SONIA transition that reinforces the determination of the FCA and the BoE that there will be no winners or losers from this process. Tagging on other updates would be outwith the spirit of this.

There is no reason to wait; all the jigsaw pieces exist and with some preparation and training, and with the engagement of lenders in a standardised process, the transition ought to be relatively painless.

Adrian Jolliffe, managing director, 2TIX