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On 16 January 2020, the Bank of England (the "BoE"),
the UK Financial Conduct Authority (the "FCA") and the
Working Group on Sterling Risk-Free Reference Rates
("RFRWG") published a set of documents outlining
priorities and milestones for 2020 on LIBOR
UK regulators have signalled that 2020 is a critical year in the
transition efforts from LIBOR to alternative risk-free rates such
as the Sterling Overnight Index Average ("SONIA"), the
RFRWG recommended replacement rate for Sterling LIBOR-referenced
transactions. The suite of publications released last month set out
key priorities and milestones for transition progress in 2020, and
help to provide greater clarity on a number of issues central to
LIBOR transition. An overarching theme of the documents (and the
heading of the associated press release) is that for affected
market participants, both on the sell- and buy-side, "the time
to act is now". In this alert memorandum, we highlight the key
priorities and expectations set out by the BoE, the FCA and the
RFRWG for 2020, as well as providing an update on some of the
issues addressed by the publications. We also include a checklist
of things the buy-side should know in order to prepare for LIBOR
discontinuation and guidance for bond issuers looking to amend
their legacy floating rate notes.
PRIORITIES AND EXPECTATIONS FOR 2020
||BoE & FCA
- No new issuances of GBP LIBOR-based cash products maturing
beyond 2021 by end of Q3 2020.
- Taking steps throughout 2020 to promote and enable widespread
use of SONIA compounded in arrears ("Compounded SONIA")
and demonstrate that it is easily accessible and usable.
- Taking steps to enable a further shift in volumes from GBP
LIBOR to SONIA in the derivative markets.
- Establish a clear framework to manage transition of legacy
LIBOR products to significantly reduce the stock of Sterling LIBOR
referencing contracts by Q1 2021.
- Considering how best to address issues relating to "tough
- The BoE and FCA support the targets set by the RFRWG.
- The intention is that Sterling LIBOR will cease to
exist after the end of 2021. No firm should plan
- Action in the following areas is key and should feature in
firms' planning from Q1 2020:
- product development;
- reviewing infrastructure, including updating loan system
- client communications and awareness; and
- updating documentation.
- Market makers should work to ensure the market standard for
Sterling interest rate swaps is SONIA from 2 March 2020
|2020 ROADMAP – KEY
- "Tough Legacy" paper expected to be published by the
RFRWG Tough Legacy Task Force in mid-Q1 2020 establishing the
anticipated extent of "tough legacy" contracts,
particular factors which make these "tough legacy"
contracts less likely to be able to convert away from LIBOR and any
potential mitigants suggested by market participants to address the
- A "beta" forward-looking Term SONIA Reference Rate
("TSRR") is expected to be published for testing purposes
by end-Q1 2020.
- Market makers are encouraged to switch the convention for
Sterling interest rate swaps from LIBOR to SONIA on 2 March
- The end of Q1 2020 is targeted for key infrastructure to become
available from Treasury Management Systems and loan vendors to use
- ISDA protocol on IBOR Fallbacks for 2006 ISDA Definitions (the
"ISDA Protocol") is expected to be published by end-Q1
- Summary feedback on the RFRWG consultations on credit spread
adjustments for SONIA in cash products is expected to be published
in mid-Q2 2020.
- A cash legacy transition paper is expected to be published by
the RFRWG in Q2 2020 to assist participants in amending legacy
loans referencing LIBOR by Q1 2021.
- The expected target for adoption of the ISDA Protocol is end of
- Provisional live TSRR aimed to be published by administrators
in Q3 2020.
- Target for end of Q3 2020 for no more new GBP LIBOR cash
|CLARIFICATION OF CERTAIN
ISSUES IN 2020
|WHAT IS THE TERM SONIA
REFERENCE RATE AND IS IT APPLICABLE TO MY BUSINESS?
- In April 2017, the RFRWG recommended SONIA as their preferred
risk-free rate ("RFR") replacement for GBP LIBOR.
- Compounded SONIA has been traded in the derivatives market for
over 20 years. SONIA is an overnight interest rate that is
calculated using an average of the previous day's
Sterling-denominated deposit transactions. Compounded SONIA relies
on a compounding methodology to calculate SONIA over a longer
interest period. The daily values of SONIA throughout the relevant
interest period are compounded, with the calculated rate being set
a few days in advance of the payment date to allow for the payment
to be known in advance and settled.
- However, due to its backward looking nature, and the short
lag-time between the rate becoming known and payment becoming due,
Compounded SONIA may not be appropriate for all types of borrowers
- Smaller corporate, wealth and retail clients, for whom
simplicity and/or payment certainty is a key factor, may wish to
consider alternative rates, such as TSRR, which is a
forward-looking rate based on SONIA overnight indexed swap
- Trade and working capital products that use forward discounted
cash flows may require a forward- looking rate, as might export
finance and emerging market loan clients that require much more
time to make payments of interest.
- It will likely not be appropriate for Islamic finance products
to utilise Compounded SONIA, because the variable rate of return
needs to be pre-determined.
- Four administrators (FTSE Russell, ICE Benchmark
Administration, Refinitiv and IHS Markit) are working on the
development of TSRR. It is expected that TSRRs will be published in
Q1 2020 for a period of observation so that market participants can
understand the nature and behaviour of the rates before they are
- UK authorities have made clear their preference for the market
to adopt a broad-based transition to Compounded SONIA, with the use
of TSRR being limited. Regulators have identified certain key
benefits of Compounded SONIA over TSRR:
- Compounded SONIA is more robust than the prospective TSRR,
because the volume of transactions underlying Compounded SONIA is
currently approximately 13 times the volume of transactions in the
SONIA OIS markets underlying the prospective TSRR on an average
- Compounded SONIA is becoming more widely used in the
derivatives markets. Market participants with hedged cash products
will want the rates in their cash products to be calculated on the
same basis as their derivatives to minimize the risk of a spread
developing and ensure effective hedging.
- Compounded SONIA is now the norm for sterling-denominated
floating rate notes ("FRNs"). Compounded SONIA can
therefore be used consistently across the derivatives, bonds and
- Compound-in-arrears rates will be available in all currencies
where an RFR rate is available. However, term rates will not be
made available in all currencies (for example, CHF). For
multi-currency borrowers, using Compounded SONIA supports a
consistent approach across different currencies where
- The RFRWG has released a "Decision Tree Model" to
determine whether Compounded SONIA or TSRR is more appropriate for
your business and product areas in which you have exposure. The
RFRWG considers that Compounded SONIA is likely operationally
achievable for approximately 90% by value of the Sterling LIBOR
- It is advisable to consult internally, as well as with your
product providers and professional advisors, to determine whether
Compounded SONIA is operationally workable or appropriate for your
|BOND ISSUERS TAKE NOTE:
TRANSITIONING AWAY FROM LIBOR REFERENCING BONDS BY WAY OF CONSENT
- There are still certain outstanding bond contracts which
reference Sterling LIBOR that are due to mature beyond the end of
2021. These "legacy bonds" will need to be transitioned
to a SONIA-based reference rate. A failure to transition these
legacy bonds may adversely impact the bond (for example, many
legacy bond contracts contain a fallback to a fixed rate in the
event that the floating rate cannot be determined) and create
contractual uncertainty and litigation risk.
- The RFRWG considers that the most orderly transition from LIBOR
to SONIA in floating rate bond contracts is to replace or amend
these contracts before the fallback provisions are triggered, that
is, before LIBOR is discontinued or declared by the regulators to
no longer be representative. This can be achieved by way of consent
solicitation to amend the bond conditions through bondholder
- As of the date of this alert memorandum, eight consent
solicitations with a total nominal value of £4.2 billion have
succesfully amended English law legacy bond contracts from LIBOR to
- Unless these are already explicitly provided for in the bond
terms and conditions, there are no mandatory terms governing such
transition. Parties may agree on the specific fallbacks and spread
adjustments methodologies (which are designed to minimize value
differences between LIBOR and the applicable RFR).
- In each of the consent solicitations that have taken place so
far, the interest rate provisions have been amended to reference
SONIA compounded daily in arrears plus a fixed spread adjustment
(which looks at the difference in value of LIBOR and SONIA basis
swaps over time and adds this to the original margin of the bond).
It is hoped that the publication by ISDA of finalised arrangements
for calculating a spread adjustment for fallbacks in derivatives
contracts will enhance bond market participants' confidence in
existing methodologies for calculating the spread adjustment in
relation to alternative RFRs in the floating rate bond market.
- The RFRWG has published a number of considerations for market
participants when conducting consent solicitations in order to
transition English law bonds away from LIBOR:
- Consider each legacy bond separately: Market participants
should carefully consider the suitability of consent solicitation
as an appropriate course of action in respect of each legacy bond,
in all cases assessed on its own merits.
- Consent fees and other incentives may not be appropriate: Given
it is in the interest of both issuers and bondholders to remove
exposure to LIBOR risks, consent solicitations undertaken for this
purpose have not typically involved the payment of consent fees or
any other incentives to vote for the resolutions effecting
amendment or transition away from LIBOR.
- Consider pre-announcing a consent solicitation by way
of an RNS announcement: To enable open dialogue between
issuers and bondholders regarding the terms of any consent
solicitation, issuers may consider pre-announcing a consent
solicitation by way of an RNS announcement.
- Consider any other necessary consequential
amendments: There may be necessary consequential
amendments required as a result of transitioning the relevant bonds
to a replacement RFR. Issuers and bondholders should therefore
consider the necessity and consequences of making any
additional amendments to the conditions of the bonds.
- Consider timing issues related to the pricing date for
any adjustment spreads: Parties should consider the
implications of any delay between the date on which the
extraordinary resolution is passed and the pricing date for any
adjustment spread as market prices may move. The same consideration
applies to a gap between the date on which the amendment is deemed
effective and the pricing date for the adjustment spread.
- Parties should adhere to the timing deadlines related
to the consent solicitation process: All parties to the
consent solicitation (including, as applicable, the custodians,
agents and trustees) should have regard to timing deadlines
specified in bond documentation and ensure the timely sequencing of
steps required to give effect to the consent solicitation. This
should ensure a smoother and more efficient consent solicitation
|LIBOR TRANSITION: WHAT THE
BUY-SIDE NEED TO KNOW IN 2020
- Buy-side responsibility: The responsibility
for transitioning away from LIBOR does not just fall on banks and
financial products providers. All users of a contract referencing
LIBOR must ensure that LIBOR dependence is removed by
- Establish where your LIBOR exposures are:
LIBOR references may be found in mortgages, loans, deposit
facilities, derivatives, floating rate notes as well as in
ancillary contract terms (leasing and servicing contracts), company
pension schemes, commercial contracts and discount rates used in
valuations. It is important to understand what will happen to these
contracts if LIBOR is no longer available.
- Familiarise yourself with SONIA (and the chosen RFRs
for other LIBOR currencies to which you are exposed) and what it
means for you and your business: SONIA is not a
like-for-like replacement for LIBOR and cannot be directly
substituted into existing contracts. Given the differences between
LIBOR and SONIA, your business may need to make changes to your
systems in order to use and make payments linked to SONIA. The same
exercise should be undertaken for alternative RFRs where your
business is exposed to LIBOR referencing contracts for other
- Speak to your bank, product provider, financial
services professional or advisor: Ask your bank what
preparations they are making and what that means for your business.
It is important that you understand how the new rates differ so you
are prepared when providers get in touch about transition and the
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