Sonia benchmark makes loan market debut

LONDON, July 8 (LPC) - UK transport group National Express has tapped NatWest for the first corporate loan referencing the sterling overnight index average (Sonia), in a significant step as the market transitions away from Libor to alternative risk free rates (RFR).

Sonia loans are currently limited to bilateral facilities, as banks are not yet ready to move away from the current forward-looking rate of three month Libor, and many borrowers are still in the early stages of adopting the new benchmark.

“We can’t syndicate loans until banks are ready - it will require operational adjustments and changing loan functions. We’ve seen a lot of movement in the last 9-12 months because banks need to be able to do it,” a senior banker said.

National Express’ loan is the first bilateral Sonia-linked loan under a pilot scheme operated by NatWest. It applies Sonia using daily compounding, with a five-day reset lag to give a more transparent, data-led benchmark. This methodology has already been used in the sterling floating rate note market.

The loan market has until the end of 2021 to move away from Libor benchmarks, which are widely used to benchmark interest rates for syndicated loans, bonds and derivative products as well as intercompany loans and other types of commercial contracts.

Libor rates fell into disrepute after banks were found to be manipulating the rates, and were subsequently fined billions of dollars. Regulators have been pushing to replace Libor with substitute rates based on actual transactions that are less open to market abuses.

The UK’s Financial Conduct Authority (FCA) recently called for banks to accelerate the transition away from loan products that use Libor as a reference rate.

Although loan market participants favor a Libor-like forward-looking term rate, developing an acceptable term rate methodology free from speculative elements is proving difficult. The backward-looking Sonia rate has stolen a march, despite potential issues for liquidity management and loan back office functions.

“Financial markets have already seen an initial shift towards Sonia as a reference rate, such as the bond amendment recently carried out by Associated British Ports (ABP),” Bhavin Shah, head of Libor transition for commercial banking at NatWest, said.

Last month, UK port operator ABP became the first bond issuer to switch to a Sonia-based coupon from a Libor-based coupon on an existing bond. The £65m (US$81.33m) floating rate note due 2022 switched to compounded daily Sonia from June 26. NatWest was solicitation agent on that transaction.

NatWest’s pilot scheme, which offers large corporate customers bilateral Sonia-linked loans, is expected to be launched into the wider market in the second half of 2019, after lessons learned from the project are incorporated.


Issuing the first syndicated Sonia-based loan could take some time, as banks will need to agree on a market-wide acceptable benchmark and also implement the new processes required for different interest rate calculations.

“It’s one thing to have a Sonia-linked bilateral loan, but quite another to have a widely syndicated multicurrency revolving credit facility with a large group of international banks,” a senior banker said.

While some large companies with more sophisticated financing processes may be able to adapt to compounded rates, many borrowers could find it extremely difficult to move to a backward-looking rate.

Borrowers are used to a pre-determined, forward-looking floating rate payment structure which allows them to predict their funding costs in advance. They will also have to adapt their systems to accommodate a backward-looking rate, which could prove costly and time-consuming.

For lenders, Libor rates compensate banks for making funds available in the longer term. Although a compounded rate can give a term rate, it is still based on the overnight rate and does not reflect the increased risk of lending for longer.

As the pricing, documentation and administration of syndicated loans also currently relies on forward looking term rates, banks need to make significant operational changes to make the transition.

Different risk free rates are being developed for different currencies and at are at varying stages of development, which adds to the complexity of the situation.

But whatever emerges, both borrowers and banks will have their part to play in the transition.

“The development of the Sonia lending market not only requires financial institutions to develop their products accordingly, but also requires corporates to be innovative in their approach and embrace Sonia-related change,” Simon Jenkins, NatWest’s senior director of corporate coverage, said. ($1 = 0.7992 pounds) (Editing by Tessa Walsh)