BoE notified that the Working Group on Sterling Risk-Free Reference Rates published a consultation paper on a successor rate to the GBP LIBOR in legacy bonds referencing GBP LIBOR. The consultation paper seeks feedback on whether it would be helpful for the Working Group to make a recommendation on a successor rate to GBP LIBOR for bonds on the occurrence of a permanent cessation event or a pre-cessation event. The paper also seeks feedback on the successor rate to be recommended. This consultation period will remain open until March 16, 2021.
Certain types of fallbacks in bond contracts referencing LIBOR, which will mature after the end of 2021, are intended to operate such that on the occurrence of a permanent cessation event or a pre-cessation event, an issuer would appoint an independent adviser to select a successor rate and a credit adjustment spread to be applied to such a successor rate, in each case on the basis of any formal recommendations made by a relevant nominating body or if no such recommendations have been made. The different successor rates proposed in this consultation paper are overnight SONIA (compounded in arrears) and term SONIA. The potential considerations set out in relation to the two options presented in this paper may be summarized as follows:
- Alignment with other products. Use of compounded in arrears SONIA as a successor rate (Option 1) would be consistent with the existing market conventions in a wide range of products in sterling markets, including all SONIA-linked bonds issued to date, the SONIA swaps market, and the new ISDA fallbacks for LIBOR-linked swaps. By contrast, use of a term SONIA rate (Option 2) may be more consistent with the Alternative Reference Rates Committee (ARRC) recommended fallbacks for legacy bonds linked to USD LIBOR, if a USD term rate becomes available. In case of securitizations, consistency of rates between the underlying assets and the bond may also be a relevant factor.
- Overall market structure. As noted in a statement published in January 2021, the Working Group anticipates that the large majority of sterling markets will be based on SONIA compounded in arrears, to provide the most robust foundation for the overall market structure; the Group has been working with the FICC Markets Standards Board (FMSB) to support development of a market standard for FMSB members in relation to an appropriately limited use of Term SONIA Reference Rates. The proposed FMSB standard is expected to be released for public comment in February. Once available, respondents may wish to take into account the proposed FMSB standard when considering their preferred potential successor rate for sterling bonds.
- Implementation. Respondents may wish to take into account the degree to which the potential forms of a successor rate are compatible with the existing design of contracts and processes, as changes are likely to be required under both of the available options. Greater similarity in the structure of term SONIA rates relative to LIBOR under Option 2 may allow for these changes to be limited, including in relation to firms’ approaches to cash flow planning. However, use of SONIA compounded in arrears (Option 1) may require more change relative to legacy processes but provide greater alignment with established processes for newly issued bonds, in respect of which the determination of the interest rate and amount toward the end of the interest period is not considered to be significantly problematic.
In addition, the Working Group on Sterling Risk-Free Reference Rates published a paper that sets out a potential methodology using SONIA-based rates, which could form a replacement for GBP LIBOR ICE Swap Rate (ISR). This paper is intended to support market participants to transition non-linear derivatives, structured products, and cash market instruments that reference the GBP LIBOR ISR, in line with the target milestones in the Working Group’s roadmap and priorities for 2021. The paper aims to document how the Non-Linear Derivatives Task Force (NLTF) has been considering the use of SONIA swap rates to develop a potential methodology for replacement of GBP LIBOR ISR. The replacement formula presented in this paper could be adapted to other markets where the discontinuation of the relevant ISRs is likely to trigger similar challenges. The ARRC in the U.S. has expressed an interest in this approach; consequently, the NLTF, on behalf of the Working Group and the ARRC, has agreed to engage in an international collaboration to address this issue.
Comment Due Date: March 16, 2021
Keywords: Europe, UK, Banking, Securities, LIBOR, Interest Rate Benchmark, Risk-Free Rates, Successor Rate, SONIA, Derivatives, BoE
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