FCA demands markets transition to SONIA

The UK's regulator has thrown its support behind the SONIA benchmark as a replacement for LIBOR, which could have knock-on consequences for private debt documentation.

The future of debt markets have become a little clearer this year with the UK’s financial regulator, the Financial Conduct Authority, throwing its support behind a potential replacement for the LIBOR benchmark.

In January the FCA released a statement saying that it, alongside the Bank of England, wished to change market conventions for sterling interest rate swaps from LIBOR to SONIA (Sterling Overnight Index Average) from 2 March 2020.

The move comes after the FCA signalled in 2017 that it wished to scrap LIBOR from the beginning of 2022. The LIBOR benchmark has been used to price a vast array of financial products globally including mortgages, credit cards, government bonds and loans by private debt funds. However, the benchmark became mired in scandal when it was revealed that banks around the world had been manipulating the rate, eventually leading the FCA to decide it should be replaced.

However, as PDI previously reported, the industry has yet to reach a consensus on which benchmark could replace LIBOR, potentially leaving thousands of private debt loan contracts in jeopardy as most are priced at a floating rate relative to LIBOR. There are concerns that firms are reluctant to choose to change their contracts to an alternative benchmark as they are waiting to see what other firms choose to do.

It appears the regulator is now trying to lead the way by providing its own stamp of approval to SONIA, which could lead to wider adoption of the benchmark and result in it replacing LIBOR for many products.

In its statement, the FCA said: “The market for SONIA derivatives is already well-established. Average cleared over-the-counter SONIA swaps exceeded £4.5trillion per month over the past six months, and the traded monthly notional value is now broadly equivalent to Sterling LIBOR.”

It continues: “In addition to shifting the swap market convention, the roadmap details other priorities set by the Working Group, including ceasing GBP issuance of LIBOR-based loans by third-quarter 2020 and managing down legacy LIBOR-linked swap portfolios and exposures.”

The move will be a major boost to the SONIA benchmark’s chances of becoming a replacement for LIBOR and follows news in November that Deutsche Bank had written a real estate loan to refinance Ditton Park in west London which referenced the SONIA benchmark. Other lenders are also thought to have considered the rate but not ultimately written it into their documentation.

However, with the official stamp of approval from the UK’s regulator, many more firms could now begin using SONIA as a reference rate.

Commenting on the FCA’s statement, Capco principal consultant Murray Longton said: “Financial services firms have to date adopted a ‘wait and see’ approach, with the mantra ‘this might not happen’. Previously the onus has been on banks, asset managers and corporates to work together to make calculated decisions as to how best transition from LIBOR to risk free rates. Evidently, today’s announcement from the FCA shows frustration at the rate of change and transition – it’s not happening quickly enough.”