As you will be aware the Finance Industry is gearing up for the discontinuation of LIBOR at the end of 2021 and the transition to the Sterling Overnight Index Average (SONIA) as the standard benchmark for determining interest rates on Lending transactions.
For more information see our articles written by Kath Shimmin, on SONIA on 30 January 2020 and the impact of COVID-19 on the interest rate benchmark on 22 May 2020.
Although this may seem a long way off, a huge amount of work is being done by the industry to prepare for the transition, and it’s important that businesses start thinking now about how the change could affect them.
UK Finance guide
In September UK Finance (the "collective voice for the banking and finance industry) published a useful Guide for Business Customers on the discontinuation of LIBOR which offers a really clear explanation of what is happening. – It's well worth a read. Click here to download the PDF.
Working Group on Sterling Risk Free Rates recommendations
Although we have known for some time that SONIA will be the new benchmark, there has been considerable debate on the convention to be applied to support the use of SONIA. In September, the Working Group on Sterling Risk Free Rates published its recommendations for SONIA Loan Market Convention. Click here to download the recommendations.
Summary of recommendations
- SONIA remains the Working Group’s recommended alternative to Sterling LIBOR, implemented via a compounded in arrears methodology, and loan markets should now move consistently towards this.
- Use of a Five Banking Days Lookback without Observation Shift is recommended as the standard approach by the Working Group. This aligns with the approach recommended by the Alternative Reference Rate Committee for US dollar loan markets and in the Working Group’s view is most likely to be made rapidly available. Whilst this approach is the recommendation, where lenders are also able to offer lookback with an observation shift this remains a viable and robust alternative (see the Annex below for the comparison between these two approaches).
- Where an interest rate floor is used, the Working Group recognises that it may be necessary to apply the floor to each daily interest rate before compounding.
- Prepayments. The Working Group recommends that accrued interest should be paid at the time of principal prepayment.
Loan Market Association (LMA) documents
The LMA have published an exposure draft of a compounded SONIA based Sterling Term and Revolving Facilities Agreement and notes.
In our next issue we will examine in more detail how these documents work.
These are available on the LMA Website.
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